Where next for BHP? The Hills are alive with the sound of Iron Ore….and Cash-flow
Our 2013 Forecast for BHP! There can be no question that the present operating environment has been a tough one for many companies, and no more so than for BHP – a company that we consider to be one of the world’s finest.
As is typical for a resources giant such as BHP, the ability to respond to market conditions, comes with quite some lag time. For example, how do you decide to go ahead with or cancel a $2bn Capital Expenditure project with a three year lead time, based on the latest set of economic figures? It’s certainly not like switching a light bulb on and off or adjusting your Pay Per Click campaign! As a result, massive planning and objectivity are key, and BHP’s board have displayed a decent track record here.
BHP has been a primary beneficiary of Chinese demand for iron ore, not only to build its infrastructure, but also for the manufacturing and export sectors. As a result, the stock has enjoyed an incredible run – from $16.85 in 2005 to a high of $49.81 in 2011. Big capital swings, for sure, and even some dividends too.
On lifting the bonnet, BHP is a truly diversified giant. Interests range from Uranium and Oil production through to Iron ore and coal. What’s more, in spite of criticism, its Board have done a reasonable job of not letting their current stockpile of cash burn too big a hole in their pocket.
Much maligned for the non-acquisition of RIO, Marius Kloppers has stood up to the criticism surrounding their decision of not going ahead ($140/share and RIO is currently $59.87). That takes strength of character – not to mention an objectivity and lack of ego – to chose to walk away, despite $100’s of millions on due diligence. Now of course, the more recent acquisition from Chesapeake Oil (which we reckon has legs) in the US, has again seen the knives come out for Kloppers, while the political fall-out from Olympic Dam has also raised criticism.
All of that aside, what would we expect to see from BHP in 2013?
Iron ore prices have kicked in again, following a sharp decline over recent months. Given the proximity and lower freight costs than Vale, of Brazil, BHP has been well placed. Additionally, the maturity of its assets and infrastructure has meant a lower cost per tonne than many of its newer and shall we say, junior competitors. As a result, its margins, while squeezed, have still been lucrative (despite the mining super tax). One development a few months ago, was the turning back by many of the Chinese customers of Iron ore shipments, meaning a renegotiation from the 3 month forward to actual spot – nice strategy if you can pull it off – when prices were falling. However, with supply and demand evening out, the glory days of SUPERNORMAL profits, may for the moment be on hold.
As a result, our 2013 Forecast for BHP is to see the stock remain largely in the $33/35 range it has traded in for the past couple of months. Now there may be some shorter term breaks out of this range, based on headlines and events, but the days of $200/tonne are long since gone.
Now what can you do with this? How about generate some solid cashflow from the stock, by treating it as a genuine asset and deriving income from it.
Here is an example of what many of our clients are doing, using BHP as the underlying asset from which, they are deriving cashflow:
|1000 BHP purchased @ $33.97||$33,970|
|MONTH 1 (Oct) Sold Nov Calls||$895||2.6%|
|MONTH 2 (Dec) Sold Jan Calls||$915||2.7%|
|Total Income to date||$1,810||5.3%|
|Profit on stock if exercised at $34.50||$530||1.56%|
|Total Return if exercised||$2340||6.9%|
|New break-even on stock||$32.16|
Not including brokerage.
Currently the stock is 34.57, which will give this client a total gross income of $2,340 or 6.9% for around 90 days, if they are exercised. From there, we simply look to re-enter the stock on a pull back and go again. It makes sense, and it makes dollars too – why? Because actively managed, a quality stock like BHP, along with a robust trading strategy, like covered calls, will give you greater control of your outcome and income.