It
provides exposure to resource prices, foreign exchange markets, foreign stock
markets, and indirectly to developing economies
The
impact of the strong dollar on BHP Billiton is complicated and easy to
underestimate: its output is priced in dollars.
Thus,
there are numerous reasons to think the stock is attractive now, including the
price of the stock
As a leading global resource company, BHP Billiton
is widely followed and well-known. BHP
Billiton trades under two symbols BBL and BHP.
Which is the most attractive investment for an individual depends on tax
considerations which are beyond the scope of this posting. Rather, throughout this posting the reference
will be to BBL since it is the appropriate vehicle for most US investors. Because BBL is so well known, this posting
skips doing a detailed description of the company. However, a few things are worth noting
because they relate to the thesis of this posting.
BBL is actually in two businesses. One is the operation of extractive activities
(mines and wells). The second is the
allocation of capital across the development of those resources including the
acquisition and sale of those mines and wells.
The company's history would suggest that it is good at both businesses. One might argue that there is a third
activity: acquiring the right to develop the resources, but as is done above, it
is equally legitimate to just consider acquiring rights as a part of
acquisition and sale of those mines and wells.
Commodity prices can fluctuate over long cycles
where the change in prices can be quite substantial and open to being confused
with a trend. At the same time,
commodity prices can react violently over very short periods of time. Nevertheless, BBL has been able to maintain a
reasonably stable dividend. Yet, the
instability in commodity prices and the consequent fluctuation in the price of
BBL’s stock deters some dividend growth investors. The thesis of this article is that BBL
provides diversification that belongs in a dividend growth portfolio, and now
is a good time to add that diversification.
Many dividend growth stocks are consumers of natural
resources. That is less true of the
pharmaceuticals and consumer staples than the industrials. BBL’s exposure to resource prices is the
opposite of many industrial firms and thus provides a mild hedge. It is only a mild hedge because the same
economic prosperity that affects industrial demand can also affect the demand
for resources. However, the lead times
for developing extractive resources are quite different from those associated
with investments in industrial activities. Therefore, commodity cycles can
develop independent of the business cycle.
For US investors, BBL also provides access to
foreign stock markets, a form of diversification recommended by many financial
advisors. If unhedged for the foreign
exchange risk, it provides diversification across currencies. Also, developing economies are often the major
consumers of natural resources. Thus,
BBL provides exposure to developing markets indirectly. Consequently, BBL’s
stock can be quite volatile, but overlong holding periods it is not highly
correlated with general market volatility.
The beta for BBL is less than one (about .9). Thus, despite the volatility of BBL’s stock
price, it can work to stabilize a portfolio.
The volatility in the stock's price means that the timing of purchases
is very important.
BBL is a global company with operations in many
countries. Its Australian mining
operations are often the focus of analyses, but they are hardly the totality of
the company. That is an important
consideration because, as a multinational, BBL is operating in many different
currencies. It also develops a broad
range of extractive resources, and the prices of most of the commodities BBL
develops are quoted in US dollars.
A recent analysis of BBL on SeekingAlpha focused on
iron ore prices, “BHP Billiton: A High-Yielding Wait For The Iron Ore Turnaround.” This is very good analysis
covering both the company's current strategy and the stock’s valuation with a
good description of why iron ore is becoming increasingly important to BBL. However, when reviewing the analysis, one
should keep in mind that iron ore prices are presented in US dollars. The strong US dollar means that, while iron
ore prices may continue to drop for US consumers, they could simultaneously
rise in weak currencies because of the dollar’s affect. As pointed out above, that is true of many of
the resources BBL develops. They are
priced in international markets in US dollars.
The dollars affect could benefit BBL in a number of
ways. First, when it comes to operating
their businesses, they may produce and sell in areas where the currencies are
weak relative to the dollar. At the same
time, their pricing is based upon the dollar.
Thus, they reap the benefit of operating in weak currency environment
without the pressure of having to sell priced in that weak currency. In terms of the spread between their cost and
their prices, the foreign exchange impact is as if they produced in weak
currency and sold in a strong currency country.
Second, since they operate in multiple countries, they can gear down or
sell operations in strong currency environments and gear up in a weak currency
environment. At a global level that will
reduce their cost.
Because the currency effects are secondary to the
issues addressed in the analysis in the article cited above, they often get
ignored. Many investors will just trust
the management of the company to navigate the issues associated with currency fluctuations. In the case of BBL, the inclination is to
recognize the management has negotiated currency fluctuations in the past and
assume that they are continuing to do so.
Further, there continue to be indications that faith in BBL's management
is justified. For example, the article
cited above mentions that BBL is exiting its low margin coal business in South
Africa, but unlike some of the other divestitures, it is not exiting the coal
business. Rather, it is just adjusting
which assets it retains in which countries.
Similarly, BBL is gearing back its exposure to oil and gas in the US at
the same time it is analyzing the desirability of increasing its exposure in
oil and gas in Mexico.
In summary, for US investors a strong dollar will
make the dollar price of BBL’s lower, but the company’s performance should not
be adversely affected by the strong US dollar.
In fact, the company may actually benefit from the strong US dollar. The company operates in so many countries
that it is probably best to just view it as operating in an environment of
multiple countries with weak foreign currencies. Those countries include both the sources
(i.e., points of production) and markets for BBL. The net effect is that it is a multinational
company that is not adversely affected by the US dollar. It is producing in weak currency countries
and selling at prices quoted in a strong currency. Many dividend growth stocks are going to be
adversely affected by the strong US dollar.
Thus, BBL may offset some of the negative impact.
A previous posting on the Hedged Economist
(Rebalancing and Risk) discussed selling two international stock mutual funds
that had been long-term holdings and shifting to individual stock positions
where the foreign currency risk was easier to understand and more appropriate
given the rest of the portfolio. BBL
fits that description perfectly. That
BBL is a potentially good fit in a dividend growth portfolio has been true for
quite a while. However, because the
stock fluctuates with commodity prices and foreign currency rates, prudence
required waiting a number of years until it became attractive. The combination of the strong dollar and the
overreaction to the commodity cycle has finally made it an attractive
purchase.
Unlike the author of the SeekingAlpha article
entitled “Recent Buy: BHP Billiton PLC,” I did not try to average in. The reasons for thinking it is attractive are
the same as those discussed in the article (PE, yield, restructuring,
etc.). Nevertheless, perhaps out of
frustration after waiting for a number of years for the opportunity, a need to
maintain international exposure, or just out of overconfidence, when the stock
was under $44 it seemed to justify making the entire planned purchase. BBL now has my targeted portfolio weight and
contributes my targeted portion of the dividend flow from my portfolio. At $44 a share, that has been accomplished at
a reasonable price. However, both in
terms of portfolio benefits and the stock’s valuation, purchases at any price
under $50 seems justified.
No comments:
Post a Comment