Morgan Stanley is out with a ‘’buy’’ on BHP today, putting a compelling new version of the old case that the share price should be higher since it trades at a 30 per cent discount to the low-growth ASX200.
They could be right but resources stocks have always traded at a discount to industrials. And here we are, China-super-boom still in full swing – despite a few ructions in the Old World – and that discount lingers.
As usual, it reflects the ample risks of a downswing in the commodities cycle, of China blowing up. Says Morgan Stanley:
“We see its EBITDA margin, gearing and yield as all being more attractive than those of ASX 200 Industrials yet it trades at a 30 per cent discount. Earnings cyclicality remains but we find an argument can be made for mispricing”.
Indeed. Compared with the industrials, BHP’s gearing is half, its margins are double (50 per cent EBITDA) and its yield is roughly the same. Its forward PE is 8.1 and it’s spitting out cash like there’s no tomorrow, for goodness sake.
The broker has a point. It does seem cheap in view of the already-funded compound annual growth rate of 6 per cent out to 2020. It has the bona fides:
“The data shows that over the past decade, BHPB has achieved a seven-fold increase in EBITDA, a 60% increase in EBITDA Margin (to ~50%), a 70% reduction in gearing (to ~10%), and a five-fold increase in the progressive dividend. Yet the market is now paying just 7x EV/EBITDA for the company compared to 12x at the start of the last decade.”
Even on its own historical PE average of 11.5x the Big Anglo-South-African-Australian is trading at a large discount. So there is a lot of risk priced into the stock for the potential for China/Asia to tank.
But BHP’s big problem is it’s too big. It’s three biggest deals – the Rio takeover, the Rio Pilbara tie-up and the Canadian Potash tilt – all failed. The latest deal of any size, shale gas in the US, looks overpriced and unlikely to make a real difference to the bottom line.
If BHP really wanted to unlock some value for share holders it would demerge, split its divisions up – iron ore, petroleum, minerals.
Unlike mergers, which boast less than a 50 per cent success rate, demergers usually deliver significant gains for share holders. And with a company this size, which is bound to bump into antitrust roadblocks wherever it goes, a demerger makes sense.
Meantime, Morgan Stanley’s case for BHP to be priced as an industrial stock is well put – but the gap is unlikely to close, especially at a time of global economic crisis. If the world sails through problems in the US and Europe – and the China boom keeps going – you could buy BHP to $100.