In broking you do encounter many episodes of déjà vu. Right here, right now the capitulation in leading and wannabe Australian resource stocks is identical to what occurred at the peak of the US banking crisis in 2008. The difference is the underlying commodities haven’t collapsed.
I remember back in 2008 getting hundreds of emails about the end of the commodity cycle, the end of Chinese demand, the end of commodity equities as we knew them, mass outflows/redemptions from commodity funds, Fortescue (FMG) going broke etc etc. BHP Billiton (BHP) bottomed at $21.90 then subsequently rallied to a high of $48.00 within 18 months. The gains in smaller, riskier Australian resource stocks were even more dramatic.
Déjà vu, but this is not 2008
However, this 2012 European sovereign debt and associated banking crisis has been far less dramatic in terms of commodity price falls than the 2008 experience. The difference between 2012 and 2008 is that the Lehman collapse and subsequent trade finance/credit collapse was sudden and caught EVERYONE unaware. The European sovereign/banking crisis has been a three-year slow burn, which in turn has dragged down Chinese economic growth. It can hardly be described as a ‘surprise’ and that is why corporations and individuals are holding record cash hoards.
Yet what the market underestimated back in 2008 was the twin power of trade finance being re-established and the commodity supply response becoming non-existent. As global growth reaccelerated, the world was again caught under-supplied in key commodities, which led to aggressive commodity price rises and aggressive share price rises in those who controlled large, low cost production bases.
This time around will be no different in my view.
In 2008, the bottom was China Inc’s attempt to buy Rio Tinto. That was the signal and I can’t help but think China Inc’s twin pieces of merger and acquisition (M&A) action in the global resource sector this week was that signal. Of course, when everyone is bearish/capitulating, the natural response is to dismiss these signals, but with the benefit of hindsight, it will prove to be one. Only time will prove me right on that.
The stock that bottomed first in 2008 was BHP Billiton. That was because it became ridiculously cheap, had a pristine balance sheet, and was still profitable even at the low point of the commodities rout due to its place at the bottom of every cost curve.
This time around, BHP is fractionally more indebted than in 2008 due to the US Gas purchases, yet where commodity prices are today (plus their production growth since), the company is dramatically more profitable.
They are making money every day the sun shines, but from the share price performance you could be tricked into thinking their earnings had collapsed. Believe it or not, consensus full-year 2012 forecasts for BHP actually rose after the solid fourth quarter production report, yet the stock went into free-fall because Spanish bond yields rose.
Today I wanted to simply look at BHP consensus forecasts for fiscal 2012 and 2013. My view remains that BHP’s full-year 2012 result in August will be a ‘buy the fact/short cover the fact’ event as the company tones down capex intentions and steps up the final ‘progressive’ dividend.
Instead of writing some ‘what if’ downside scenario to justify the current BHP share price, I want you to consider ‘what if’ BHP’s full-year 2013 consensus forecasts prove right?
I don’t believe there is any value at all generated by running ‘downside scenario’ analysis AFTER a $20 correction in BHP shares. Just look how solid the numbers are for 2013 in the table below.
The consensus view is that earnings per share (EPS) grow as production growth kicks in. The stock drops to trading on 6.1-times operating cashflow, generated from 48% earnings before interest, tax, depreciation and amortisation (EBITDA) margins. On current consensus forecasts, the payout ratio is 35%, which generates a 4% dividend yield. If the payout ratio was lifted to 50%, the stock would yield a prospective 5.5%, which is highly competitive with leading industrials that command up to double the EV/EBITDA multiples. BHP on 5.2-times enterprise value/EBITDA will prove grossly cheap, particularly if they lower the capex intentions.
Think of it this way. If BHP was simply to rally to its historic average price to earnings (P/E) ratio of 11-times its FY2013 consensus earnings, the share price target would be $36.74. If they concurrently lifted the payout ratio to 50%, the yield would be 5.5%, driving a total return of 26%.
As I have been saying, I believe the BHP Board and management are listening to the feedback about getting the balance between capex and dividends right. This should be confirmed when they report a $17 billion annual profit in August.
On that basis and considering the deep value in BHP shares, it is time to be a complete contrarian, shut your eyes, and buy some BHP into this capitulation stage, which will prove no different to 2008.
This is the bottom in Australian metals and mining equities. Right here, right now is my view. Straw hats in winter.
BHP Billiton (BHP)
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