Two years ago, investing in mega-miner BHP Billiton (LSE: BLT) (NYSE: BBL.US) was almost a contrarian move. BHP shares had fallen heavily and traded on a single-digit price-to-earnings ratio, thanks to strong historic earnings.
Meanwhile, many investors were steering clear of commodities, due to widespread fear of a dramatic economic slowdown in China.
Two years later…
As we approach the end of 2013, China’s government looks increasingly likely to pull off a ‘soft landing’. Economic reforms are being gradually applied to boost domestic consumption and raise living standards, without suddenly derailing China’s manufacturing industry or its construction boom.
Similarly, after a difficult year of write-downs and one-off losses, BHP appears poised to deliver solid profits and appealing dividend yields, thanks to a new management focus on shareholder returns, rather than expansion at any cost.
As a result, BHP now boasts massive support from City analysts – according to Reuters, 18 analysts have a buy or outperform rating on BHP, 6 rate it as a hold, and just 3 have an underperform rating. None rate it as a sell.
I don’t know about you, but when the highly-paid yet sheep-like minds of the City all agree on something, I wonder whether the picture is about to change.
Will BHP’s profits plateau?
Like Rio Tinto, BHP is in the final stages of expanding iron ore production, a move which seems likely to consolidate the two firms’ grip on the iron ore market, while dampening down iron ore prices and cutting the firms’ (admittedly high) profit margins.
Nearly half of BHP’s profits now come from its petroleum division, which is very sensitive to changing oil and gas prices. Even a small fall in oil prices, such as we are currently seeing, could cut profits, cancelling out any increase in production.
Does BHP still look cheap?
BHP shares have gained less than 1% over the last two years, and currently trade on a 2013 forecast of 11.6, with a prospective yield of 4.0%.
This P/E rating is significantly higher than both iron ore giant Rio, which has a forecast P/E of 10.0, and petroleum producers Royal Dutch Shell and BP, which both trade on forward earnings multiples of less than 9.
In my view, there’s little reason to expect BHP’s production and profits to outperform these peers, so investors seeking above-average total returns might do well to sell BHP, and look elsewhere.