BHP - BHP Group

[Mr_T]

BHP double in the next year? Possible but highly unlikely.

This would give it a P/E ratio of over 30. The only thing that would justify such a high P/E is strong expectations of extraordinary profit growths for the next few years.

Given that the general consensus is for moderate profit growth in the next year or so, I can't see how a P/E of 30 is in any way justified in BHP's case. 20 maybe...but not 30.

Of course it might get up to such a high price based on a speculative bubble, but as has been said before, if its not supported by fundamentals, it just won't stay there.

 

[vishalt]

Great post Garpal, I agree with your analysis but yeah $100 is extremely high on the enthusiasm scale.

I think it depends on a lot of factors:

1) Strong currency will eat into the profits, I think it will cause a bit of a slowdown in growth, we're in our tightening cycle while the US is loosening their rates.

2) Commodity prices are still consolidating, they're still expensive at the moment but they need to go up more to negate the currency factor.

3) If the US does slowdown, I believe it'll take our market down initially with it for a hefty correction, but I strong believe that we'll diverge and be able to shield against a US bear market because of China's demand.

4) If BHP gulps Rio, the merging process will be very extensive, these companies are massive and have long histories - so we could see some extensive consolidation.

5) If BHP gets a knockback I think we could both shares fall because institutions will pull out, before they go back again (just like Alcoa).

Based on current P/E ratios, Rio is 23, BHP is 16, that is a RIDICULOUS discount of nearly 30%, i.e BHP right now from $42 should be trading at $56 to match Rio.


If institutions/commentators/analysts truly believe Rio is worth that much in (given P/E) - and that its net profit declined 6% last year - I think BHP will after a while go ballistic.

Another bid for Rio could see it go to $150, the P/E could shoot to like 25 or even 28, making BHP $60+ in that comparison, I think its looking very healthy!

 

[Mr_T]

Great post Garpal, I agree with your analysis but yeah $100 is extremely high on the enthusiasm scale.

I think it depends on a lot of factors:

1) Strong currency will eat into the profits, I think it will cause a bit of a slowdown in growth, we're in our tightening cycle while the US is loosening their rates.

2) Commodity prices are still consolidating, they're still expensive at the moment but they need to go up more to negate the currency factor.

3) If the US does slowdown, I believe it'll take our market down initially with it for a hefty correction, but I strong believe that we'll diverge and be able to shield against a US bear market because of China's demand.

4) If BHP gulps Rio, the merging process will be very extensive, these companies are massive and have long histories - so we could see some extensive consolidation.

5) If BHP gets a knockback I think we could both shares fall because institutions will pull out, before they go back again (just like Alcoa).

Based on current P/E ratios, Rio is 23, BHP is 16, that is a RIDICULOUS discount of nearly 30%, i.e BHP right now from $42 should be trading at $56 to match Rio.


If institutions/commentators/analysts truly believe Rio is worth that much in (given P/E) - and that its net profit declined 6% last year - I think BHP will after a while go ballistic.

Another bid for Rio could see it go to $150, the P/E could shoot to like 25 or even 28, making BHP $60+ in that comparison, I think its looking very healthy!

No no no no no. Rio's comparatively high P/E is due to BHP willing to pay so much for them.

Rio is the one that is being overpaid - high P/E.

BHP is the one that is doing the overpaying - nothing to justify a high P/E. Arguably should even have a lower one due to overpaying.

 

[vishalt]

No no no no no. Rio's comparatively high P/E is due to BHP willing to pay so much for them.

Rio is the one that is being overpaid - high P/E.

BHP is the one that is doing the overpaying - nothing to justify a high P/E. Arguably should even have a lower one due to overpaying.

Yes yes yes yes yes. You think BHP is "overpaying" for the business - I think that BHP is saying "here's how much we think you'll be worth soon, we'll give you your future value now, so lets merge".

BHP believes that in time Rio will be worth $140+ in a few earnings time, equating to a P/E bump, if Rio could be worth that much what would happen to BHP, which is biggest and strongest?

 

[rederob]

Garpal
I enjoyed your enthusiastic approach to pricing BHP.
For those querying BHP's capacity to double in 12 months, just remember that it has done this already in the past 3 years.
BHP rose from $15.55 on 16May05 to $32.00 on 11May06 (on closing prices).
BHP fell 2 cents shorts of doubling on closing prices when it peaked on 18Oct07 at $47.70 after having come of its low of $23.86 on 8Jan07.

Could BHP sustain a doubled price if it took over RIO?
In the short term it's always hard as integration costs make the balance sheet look initially sad.
In out years the synergies would be in place, and BHP would have very few global competitors to worry about in its price-setting negotiations.
If you are wondering how it works out in BHP's favour, think of it being analogous to the common advantages of "compounding".
For example, imagine that in the first year of China negotiations without a "RIO" to compete against, BHP got a 50% increase in iron ore (instead of a 30% increase which would have been a more reasonable expectation in a competitive market). Then in the second year there is a global recession and China wants to reverse the previous year's increase, but BHP says, instead, we will hold prices steady and review them next year if things have not picked up. In the third year things pick up and a price increase is back on the table.
Using this scenario as an analogy, BHP picks up a 20percentage point greater price increase in the first year, and holds onto in the second year because of its bargaining power. Then in the third year it leverages off the initial year's price increase.
In the scenario where RIO was a competitor, BHP would have been back to scratch at year 3, and would be in negotiation from a base case of 30% increases rather than 50%.
Do the maths over a further 5 years comparing the 2 scenarios, adding 5% annual price increases, and see how much further ahead BHP would be - pretty stunning outcome!

 

[haemitite]

The market isn't going to price BHP on the integration costs, they will be noted as one off impacts and then ignored. Its already clear that the market see enormous upside as BHP has basically been flat even with the inferred premium going to RIO

 

[rederob]

The market isn't going to price BHP on the integration costs, they will be noted as one off impacts and then ignored. Its already clear that the market see enormous upside as BHP has basically been flat even with the inferred premium going to RIO

True.
But the market has institutional and private investors.
Private investors are keener for something immediate.
Right now private investors are not jumping onto BHP: They want the dust to settle.
Institutional investors that are BHP holders - which ones are not!!! - may take some BHP off the the table, but clearly present price action shows they are more probably still "holding" firm.
Private holders, myself included, with a long term view are not likely to sell either, unless the news on markets generally becomes unfavourable.
My view has always been that it is more likely that BHP professionals have a much keener insight into forward probabilities than the average investor. They will be paying lawyers and consultants millions$$ until RIO rolls over.

 

[Mr_T]

Yes yes yes yes yes. You think BHP is "overpaying" for the business - I think that BHP is saying "here's how much we think you'll be worth soon, we'll give you your future value now, so lets merge".

BHP believes that in time Rio will be worth $140+ in a few earnings time, equating to a P/E bump, if Rio could be worth that much what would happen to BHP, which is biggest and strongest?

How much it will be worth soon is not the same as how much it is worth now. For 2 reasons a) its future price is speculation and b) time value of money.

RIO's price is now artficially inflated due to it being a takeover target. Comparisons between itself and BHP are truly an apple v pear issue.

 

[Mr_T]

True.
My view has always been that it is more likely that BHP professionals have a much keener insight into forward probabilities than the average investor. They will be paying lawyers and consultants millions$$ until RIO rolls over.

Do high up BHP big guns have more knowledge about the costs v benefits of a RIO takeover than a simpleton shareholder like little me? Why of course. So on the face of it, if they want it, it is the right thing to do - they are the ones with the information, corporate experience, intelligence, business instincts, etc etc etc. All those things that most shareholders don't have.

In the real world however that's not how things always work out. For many reasons. IMHO, one of them being that they are (like everyone) biased. Since these high flyers tend to be overly confident and egotistical (not always, but often) their quest for infinite power and growth of their organisation will lead them to subconsciously magnify benefits and downplay the risks of such a takeover. And out the window goes good sensible judgement.

 

[hacheln_mice]

Well, it looks like I may indeed get to buy near my preferred price range on Monday. There looks to be a tradeable bounce coming near 41.3-41.6 should it hit that area.

If prices fail to stabilise there, then we could get further selling down to the 39.4 area.

-----------------------

 

[rederob]

In the real world however that's not how things always work out. For many reasons. IMHO, one of them being that they are (like everyone) biased. Since these high flyers tend to be overly confident and egotistical (not always, but often) their quest for infinite power and growth of their organisation will lead them to subconsciously magnify benefits and downplay the risks of such a takeover. And out the window goes good sensible judgement.

Does that explain why Gilbertson got the boot for approaching RIO without the BHP Board's approval some years back?
This is not a new plan.
The industrialisation of over 2 billion people over the next generation or two will make post WWII western industrialisation of a fraction that number pale into insignificance.
Lest we forget.

 

[Mr_T]

Does that explain why Gilbertson got the boot for approaching RIO without the BHP Board's approval some years back?
This is not a new plan.
The industrialisation of over 2 billion people over the next generation or two will make post WWII western industrialisation of a fraction that number pale into insignificance.
Lest we forget.

I am not saying that companies will do anything at any price in the quest for expansion and power. I am saying that the quest for expansion and power will cloud their judgements in some situations. These things are matters of degrees, not absolutes.

I agree with your industrialization comment. I have been going to China for a few years, and for those who think that the demand for commodities has reached its peak - have I got news for you. Things are going there faster than ever, yet most people are relatively untouched by industrialization. Reality is that most Chinese don't (yet) live in Beijings/Shanghais/Guangzhous, they are peasants living on farms/rural areas with highly inadequate amenities. This is changing, and will change further, and demand for commodities will be huge in coming years.

Which means that a well managed resource company should have a good future. The emphasise being on the words "well managed". Which it clearly was under Chip. Time will tell if Marius will do a good job.

And remember, every asset has a good, bad and fair price. No one doubts that the t/over of Rio is a good thing at certain prices. But as I said in an earlier post, history has shown that most predators overpay for targets.

 

[greenfs]

My son in law is a Rio engineer. He told me they did a poll of Rio GM's on Friday and it clearly indicated that the merger is as good as a done deal, subject to BHP coming back with a much higher offer ($160+).

He indicated that if for some reason this does not happen someone else will come along & make the required offer

 

[Gurgler]

Reality is that most Chinese don't (yet) live in Beijings/Shanghais/Guangzhous, they are peasants living on farms/rural areas with highly inadequate amenities. This is changing, and will change further, and demand for commodities will be huge in coming years.

So true; here in Ningbo (one of the top 10 developing cities - that was last year) we are surrounded by vacant estates of apartments awaiting the projected migrant inflow from the rural areas (as shown in the lower pic). Before we came in Feb 2005, we were on the edge of land covered by market gardens. By early August that year they were replaced by what is in the top picture. You will also note the upsurge in construction over the two years between these two pictures (Aug 9 2005 and today). Buildings, roads and skylines change continually. These images are indicative of the growth going on in almost all cities in China.

What will happen when these apartments are filled with people using TV's, microwaves, etc.? The mind boggles! Literally the tip of the resource-demand iceberg.

 

[Mr_T]

Thanks for that Gurgler. Your pictures really do tell what words can only attempt to describe.

What is happening to China is truly amazing.

I have never been to India. Wonder to what extent the story is similar there.

 

[vishalt]

Thanks for that Gurgler. Your pictures really do tell what words can only attempt to describe.

What is happening to China is truly amazing.

I have never been to India. Wonder to what extent the story is similar there.

It's pretty much the same, a lot of people are untouched by this boom thus far, I went there 2 years ago. The major cities themselves need a lot of development .

Anyway referring to your earlier comment about price inflation - I think that's the stock market for you in a way, a lot of the stocks have inflated prices already being held up by the confidence of strong fundamentals, I won't really comment on how much BHP is paying for Rio, I have no idea of the good M&A prices.

However I totally disagree with the strategy and I hope competition watch dogs dont' allow it, it'll be an extremely powerful monopoly that could shut smaller miners down.

I think it should pursue organing growth or smaller acqusitions, WMC acqusitiion was a masterstroke, or companies like Teck Cominco, Oxiana, Woodside, smaller explorers/miners that are cheaper and have potential.

 

[haemitite]

My son in law is a Rio engineer. He told me they did a poll of Rio GM's on Friday and it clearly indicated that the merger is as good as a done deal, subject to BHP coming back with a much higher offer ($160+).

He indicated that if for some reason this does not happen someone else will come along & make the required offer

A Rio GM is 3 steps away from the CEO, its hardly as if they will have their middle management team conduct a vote on the outcome. Its a Board/CEO call

As for someone else - who?

 

[rederob]

Thanks for that Gurgler. Your pictures really do tell what words can only attempt to describe.

What is happening to China is truly amazing.

I have never been to India. Wonder to what extent the story is similar there.

It appears to be similar: Scroll through the various pictures at this site for an idea:
http://www.flickr.com/photos/85296574@N00/379244922/in/set-72157594382704326/
Below is a new high rise complex in Calcutta (Kolkata)

 

[Miner]

A Rio GM is 3 steps away from the CEO, its hardly as if they will have their middle management team conduct a vote on the outcome. Its a Board/CEO call

As for someone else - who?

Dear Haematite
Your information is very true. The GM (Stratum 4) is only two steps below CEO (No Stratum) of a business unit and MD (Stratum 5). Each Business unit like Pilbara Iron / Expansion Projects/ Asset Utilisation has an MD who reports (normally) reports to Rio Board. I am sure any one could visit www.pilbarairon.com.au or www.riotinto.com and will able to see every thing there.
I believe you are referring to Pilbara Iron aka Rio Tinto Iron ORe not necessarily Rio Tinto London Office. In the GM Conference it is attended by the MD of business unit full time and partly by the CEO. It is no fool's party.
IN the past (2006) it was only talked about increasing the capacity to 300 MTPA and today it becomes a game plan.

So I am sure what your son in law saw will be true in action.

I am a Miner .

Regards

 

[GREENS]

Nice post Red! (#1243)

I think in the end BHP will be willing to pay a bit extra even if many will regard the offer as expensive because of the following:

1.Monopoly power - as soon as BHP gets its hands on RIO’s assets it will have a near monopoly position (or the upper hand in a oligopoly cartel) that will inturn give the company an even more powerful say in how metal prices particularly Iron Ore, Copper, Coal, Aluminium and Uranium are determined in the markets. Similar to what Red said about the pricing of Iron Ore. Given this dominant position the potential for much higher profits are obvious.

2.Leverage to Chindia’s Mouth – The main commodities that RIO produce, Iron Ore, Coal, Uranium and Copper are basically the 4 main commodities with the exception of oil and gas that be in strong demand from China and India over the coming decade (if not decades). The reasoning, China and India already need substantial amounts of energy to operate their economies, and this demand is only going to grow as these nations continue to rapidly develop into economies like the rest of the western world. & if these nations are worried about emissions at the moment Uranium seems to be the only suitable alternative to dirty coal, put two and two together and Uranium will be one of the most sought after commodities over the next decade. Furthermore the construction boom that China is currently in and India has really yet to start will underpin the demand for Iron ore, Nickel and Copper.

3.The synergies – Don’t have to really go on about this, it should seem quite obvious throughout the globe they have a lot of projects in close proximity e.g. Pilbara region, where the one company could cut a lot of costs by combing the entity and inturn increase margins.


But will BHP double in the next year, I would highly doubt it. Why? Investors will view the RIO takeover originally as much too expensive considering the high PE multiple they would be paying for the company. The benefits from the takeover will take a couple of years to show through. Lately BHP has been trading well above its historical PE average of around 12-13 x earnings. Metal and Oil prices in AUD terms are being eroded at present from the sky rocketing AUD. I was reading in the Australian a few weeks back that a rise from an ER of 0.9 -to- parity with the USD would erode BHP profits by around 18%. That’s a staggering figure by any means the only benefit to BHP is that it reports in USD which may subdue this effect. Lastly Credit worries and the US slowdown which I believe will continue to have a ripple effect on share markets around the globe and in particular commodity markets for a while to come. I still hope to pick up more around the mid to higher thirties. LT however I think the increased market power, economies of scale (low cost operations and hence higher margins) and the significant leverage to the main commodities in demand by Chindia will underpin its growth going forward.

Suppose well have to wait and see how this pans out, it rarely goes according to plan.