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Interesting Report in Eureka
BHP Billiton, the cash machine
My view remains that the market’s obsession about whether commodity prices are sustainable is taking the focus off the "company-changing" cash flows the resource sector is spitting out.
I believe these "super cash flows" are reducing the overall risk of the sector because management is showing discipline and using those "super cash flows" to either buy back large chunks of scrip, pay special dividends, or both. These super cash flows are being returned to shareholders, and I believe that will continue.
You don't even have to believe in a "super bull" commodity scenario to see BHP Billiton generate $US30 billion of free cash flow over the next three years ”” yes, that's free cash flow after capital expenditure of $US30 billion.
My research colleague David Radclyffe ran some scenario analysis today, at commodity price forecasts that are far from "outrageous", and the results are that BHP Billiton could have up to $US30 billion of free cash flow over the next three financial years, which equates to $A7 a share (25% of the current market price).
Using an average oil price of $US60 a barrel, an average copper price of $US2 a pound, an average nickel price of $US8 a pound, iron ore up 10% and then staying flat, and flat coal prices for both thermal and coking, the calculation comes to $US30 billion of cumulative free cash flow over the next three years. Then you need to then consider what BHP will do with its huge free cashflow.
The Freeport McMoran quarterly highlights the return to shareholders when cash flows overwhelm allocated capital expenditure commitments. Freeport earned $US1.74 a share in the second quarter and paid a total dividend, including a special, of $US1.06. In the six months to June 30, the company earned net income of $US739 million and returned 61%, or $US452 million, in dividends and share buybacks. The Freeport result is an indication of the potential for BHP and Rio Tinto shareholders as capital expenditure starts to slow. As a reminder, last year BHP paid dividends of US42 ¢, or a yield of 1.4%.
As BHP turns down the capex/expansion/investment tap in 2007-08 and 2008-09, the free cash generation becomes enormous. This strong cash flow generation is expected to yield increased returns to shareholders through increased dividends and further buybacks (each $US2 billion equates to a return of about 1.6%).
So the "upside case" really isn't that optimistic, with many of our assumptions significantly below spot prices, but in line with futures curves. Let’s just say that if we used spot commodity prices and averaged them for the next three years, the free cash flow BHP spits out is obscene.
What will they do with all the money? Free cash flow of $US30 billion or potentially more is a very high-quality problem for a board to have. What a great strategic problem to have ”” what to do with $US30 billion?
I've speculated aloud about BHP taking out Shell and bidding for Woodside Petroleum, but I suspect the more likely use of the free cash flow is a combination of huge buybacks and special dividends.
Bring it home, boys
If I sat on the BHP board I would be strongly considering how to unwind the dual-listing structure. My view remains that the dual-listing is actually playing a role in contributing to BHP's low P/E rating. The ever-widening discount the (UK-based) PLC shares command reinforces just how out-of-date the structure now is and why it needs unwinding.
I think the excess free cash flow should be used to buy back the entire PLC listing. Yes, buy back the entire thing over a three-year period. Buy out the hedge fund dominated register, and return BHP to its rightful spot as a purely Australian listed company.
The beauty of this idea is that you cancel 35% of the entire BHP Billiton register through time, and have an associated earnings per share uplift due to the number of shares on issue being lower. However, the good news is that the lower number of shares on issue in no way effects BHP ASX 200 index weighting of 10% as the UK shares are not included in the ASX calculations anyway.
If you offer the Poms a cash or scrip alternative at parity, and some choose scrip, the ASX 200 weighting will actually rise due more Australian dollar-denominated shares being on issue.
If I don't say so myself, the idea is a no-brainer. I can't see how this isn't in the long-term interests of the company and its long-term shareholders. The influential funds will continue to buy the buyback-generated earnings-per-share upgrades, while 10% of every Australian compulsory superannuation dollar that finds its way into Australian equities will find its way into BHP. That compulsory super flow can be tapped for growth capital if required, and buying back the UK listing in no way constrains BHP growth or acquisition options.
The other beauty of this idea is that it reduces risk, because BHP would be investing in the asset it knows best: itself. BHP has the greatest suite of mining assets in the world, yet the dual listing is contributing to those assets being priced as some of the cheapest in the world.
I know there are tax issues in unwinding the dual-listing structure, but I believe they could be overcome. I believe this must happen, and although I am out of line telling the BHP board what to do, I am certain that if they followed the advice above that BHP would be a $A50 stock in three years time, trading on P/E multiple of 13 times. Today, we have the greatest mining company in the world trading on a single-digit P/E, with that P/E actually contracting.
The stock is basically trading at net present value ”” and that's in the middle of a commodity "super cycle". Action is required to rectify that ridiculously low rating, a rating that clearly doesn't reflect the quality or duration of the assets, the quality of the management and board, or the quality of the balance sheet and cash flows.
I'm a bit passionate about this because I believe there is huge value to be released here, and I believe a much better rating can be achieved for BHP Billiton. I'm certain BHP is considering all these options, I'm just urging directors to get on with it and back themselves. It's now or never boys, let’s take out the Poms and bring it home.
Eureka Report
BHP Billiton, the cash machine
My view remains that the market’s obsession about whether commodity prices are sustainable is taking the focus off the "company-changing" cash flows the resource sector is spitting out.
I believe these "super cash flows" are reducing the overall risk of the sector because management is showing discipline and using those "super cash flows" to either buy back large chunks of scrip, pay special dividends, or both. These super cash flows are being returned to shareholders, and I believe that will continue.
You don't even have to believe in a "super bull" commodity scenario to see BHP Billiton generate $US30 billion of free cash flow over the next three years ”” yes, that's free cash flow after capital expenditure of $US30 billion.
My research colleague David Radclyffe ran some scenario analysis today, at commodity price forecasts that are far from "outrageous", and the results are that BHP Billiton could have up to $US30 billion of free cash flow over the next three financial years, which equates to $A7 a share (25% of the current market price).
Using an average oil price of $US60 a barrel, an average copper price of $US2 a pound, an average nickel price of $US8 a pound, iron ore up 10% and then staying flat, and flat coal prices for both thermal and coking, the calculation comes to $US30 billion of cumulative free cash flow over the next three years. Then you need to then consider what BHP will do with its huge free cashflow.
The Freeport McMoran quarterly highlights the return to shareholders when cash flows overwhelm allocated capital expenditure commitments. Freeport earned $US1.74 a share in the second quarter and paid a total dividend, including a special, of $US1.06. In the six months to June 30, the company earned net income of $US739 million and returned 61%, or $US452 million, in dividends and share buybacks. The Freeport result is an indication of the potential for BHP and Rio Tinto shareholders as capital expenditure starts to slow. As a reminder, last year BHP paid dividends of US42 ¢, or a yield of 1.4%.
As BHP turns down the capex/expansion/investment tap in 2007-08 and 2008-09, the free cash generation becomes enormous. This strong cash flow generation is expected to yield increased returns to shareholders through increased dividends and further buybacks (each $US2 billion equates to a return of about 1.6%).
So the "upside case" really isn't that optimistic, with many of our assumptions significantly below spot prices, but in line with futures curves. Let’s just say that if we used spot commodity prices and averaged them for the next three years, the free cash flow BHP spits out is obscene.
What will they do with all the money? Free cash flow of $US30 billion or potentially more is a very high-quality problem for a board to have. What a great strategic problem to have ”” what to do with $US30 billion?
I've speculated aloud about BHP taking out Shell and bidding for Woodside Petroleum, but I suspect the more likely use of the free cash flow is a combination of huge buybacks and special dividends.
Bring it home, boys
If I sat on the BHP board I would be strongly considering how to unwind the dual-listing structure. My view remains that the dual-listing is actually playing a role in contributing to BHP's low P/E rating. The ever-widening discount the (UK-based) PLC shares command reinforces just how out-of-date the structure now is and why it needs unwinding.
I think the excess free cash flow should be used to buy back the entire PLC listing. Yes, buy back the entire thing over a three-year period. Buy out the hedge fund dominated register, and return BHP to its rightful spot as a purely Australian listed company.
The beauty of this idea is that you cancel 35% of the entire BHP Billiton register through time, and have an associated earnings per share uplift due to the number of shares on issue being lower. However, the good news is that the lower number of shares on issue in no way effects BHP ASX 200 index weighting of 10% as the UK shares are not included in the ASX calculations anyway.
If you offer the Poms a cash or scrip alternative at parity, and some choose scrip, the ASX 200 weighting will actually rise due more Australian dollar-denominated shares being on issue.
If I don't say so myself, the idea is a no-brainer. I can't see how this isn't in the long-term interests of the company and its long-term shareholders. The influential funds will continue to buy the buyback-generated earnings-per-share upgrades, while 10% of every Australian compulsory superannuation dollar that finds its way into Australian equities will find its way into BHP. That compulsory super flow can be tapped for growth capital if required, and buying back the UK listing in no way constrains BHP growth or acquisition options.
The other beauty of this idea is that it reduces risk, because BHP would be investing in the asset it knows best: itself. BHP has the greatest suite of mining assets in the world, yet the dual listing is contributing to those assets being priced as some of the cheapest in the world.
I know there are tax issues in unwinding the dual-listing structure, but I believe they could be overcome. I believe this must happen, and although I am out of line telling the BHP board what to do, I am certain that if they followed the advice above that BHP would be a $A50 stock in three years time, trading on P/E multiple of 13 times. Today, we have the greatest mining company in the world trading on a single-digit P/E, with that P/E actually contracting.
The stock is basically trading at net present value ”” and that's in the middle of a commodity "super cycle". Action is required to rectify that ridiculously low rating, a rating that clearly doesn't reflect the quality or duration of the assets, the quality of the management and board, or the quality of the balance sheet and cash flows.
I'm a bit passionate about this because I believe there is huge value to be released here, and I believe a much better rating can be achieved for BHP Billiton. I'm certain BHP is considering all these options, I'm just urging directors to get on with it and back themselves. It's now or never boys, let’s take out the Poms and bring it home.
Eureka Report