Questor share tip: BHP Billiton to increase cash returns

FTSE 100 miner's cost cutting and increased production should generate cash for investors. Questor says buy.

BHP Billiton wins £352m Australian tax dispute
The court ruled that BHP properly wrote off debt after building a plant that manufactured briquettes from iron ore particles in Western Australia. Credit: Photo: Reuters

BHP Billiton
£18.82+38p
Questor says BUY

THE world’s largest mining group BHP Billiton could increase the dividend, launch a share buyback, and fund a one-off return of cash to shareholders within a year, say experts. That means the income on the shares could almost double within the next 12 months. And when combined with plans to demerge un-loved assets worth A$20bn (£11bn) the shares climbed almost 3pc higher yesterday.

The mining industry has been through huge change and BHP Billiton has not been impervious. First there was the feast when China’s demand drove commodity prices higher. Diversified mining groups such as BHP Billiton went all out for growth, spending billions on new projects. But the commodities “super-cycle” slowed quickly last year forcing the industry to draw in its horns and cut costs.

China’s economic growth may have slowed to 7pc but crucially it hasavoided a hard landing and this has kept commodity prices relatively stable, albeit at lower levels.

Andrew Mackenzie, chief executive, has focused on cost cutting to protect profits and keep the company on target to cut $5.5bn in costs by June 2014, out of a total cost base of about $50bn ( during 2013. Mr Mackenzie has pledged more cuts, which has helped BHP Billiton shares hold their own this year..

The Anglo-Australian mining company has also ramped up production from its existing operations. The miner reported record production of iron ore, coal and hydrocarbons in the six months ending on December 31.

At the same time as focusing on iron ore, coal, copper and petroleum production, BHP is selling other assets.

The mining group has said “simplification of our portfolio is a priority” and analysts from JP Morgan Cazenove have identified up to $19bn from aluminium, manganese and nickel assets, including $8bn in coal mines, $3bn in Copper and $5bn in petroleum assets that could all be sold.

BHP is also making more cash. The companuy said that during the first half of the year operating cash increased by $4.7bn on the same stage a year earlier. More cash has reduced debt levels, and Mr MacKenzie has said by the annual results he will speak to investors about returning capital.

What this means for shareholders is that the mining sector could move from a growth investment story to an income one. BHP could make a share buyback announcement as soon as the annual results in August. JP Morgan Cazenove analysts estimate the share buyback could be about $3bn, while UBS analysts have said it could reach $5bn.

The miner launched its last $10bn buyback programme in 2011. Over the past decade, BHP has paid out $62bn in buy-backs and dividends to shareholders, or about half the company’s underlying earnings.

The sale of assets could boost returns further. The JP Morgan analysts think BHP could fund a special dividend of about $2.6bn by June 2015, increasing the effective dividend yield to 5.5pc.

There is one big risk to all these capital plans, namely a slump in commodity prices if China slows further. The iron ore price has fallen 12pc in the year to date to around $117 per tonne. BHP generates about half of its operating profits from iron ore. A sharp correction in commodity prices would put all these plans on hold.

Questor’s last recommendation was to buy the shares (£18.32, July 18) as the cost reduction plan opened the way for more cash returns to shareholders, and both those fundamental reasons still stand. So, the shares trading on 11 times forecast earnings retain their recommendation. Buy.