BHP is an international mining company based out of Australia, with a global operational presence. Specifically, they have begun increasing their exposure to North American assets, with petroleum production as a key area of growth.
By focusing on a strategy of growth-by-acquisition over the last few years, a cursory overview of basic financial ratios would initially suggest that the company’s ability to create returns for investors into the future is deteriorating quickly. However, by digging into the underpinnings of these ratios, we can determine that there might be more going on behind the scenes than would be initially suggested by the basic metrics, and therefore an opportunity for investors to jump in on a company that has just finished taking a bath on its intangible expenditures to save on tax expenses over the year.
Over the last two years, all off BHP’s Return on Equity, Return on Asset, and Earnings per Share metrics have declined dramatically, by approximately the same amount. While this is initially concerning, it is interesting to notice how it is that the decline in value all mainly stem from goodwill write-downs, increased financing costs from acquisitions, and various 1-time expenses. The end result is a situation where the company’s 1-year return metrics will be dramatically reduced on a non-operating basis, but will very likely bounce back in the following reporting period due to the non-continuing nature of the write-downs made.
In this specific situation, BHP wrote-down the value of the goodwill it paid for on a couple of properties that it acquired when commodity prices were higher. Since commodity prices are now lower, it is justifiable that the company will no longer be able to get the same amount of revenues out of the assets as they would have been able to with the higher prices, and therefore the company takes an intangible loss. This loss reduced tax expenses for the year, and reduced asset values, but didn’t really do much more than that because the company already paid for the assets purchased.
So what does this mean in plain English?
It means that the company is taking a hit this year, and likely going to bounce-back later in the year, because the properties it owns are still chugging away, and it’s still on track to continue putting the newly acquired assets (which have just been written down) into operations. Even with lower commodity prices, the company is still profitable, and capable of scaling its operations in a way that create returns for investors.
Assuming that the stock price of BHP today is representative of a set of temporarily reduced ROE, ROA, and EPS metrics, we can now come up with a set of hypothetical numbers illustrating what BHP’s stock price should be in the event of a correction. For the sake of conservatism, this calculation will assume that the company’s profitability metrics recover by half of what they used to be. Combined, the ROA and ROE metrics are suggesting the need for a $20-30/share increase in price, while the minimal change in the EPS metric suggests a possible change of $25-35/share. The key takeaway here is then to recognize how it is that, with all other metrics held constant, the share-price of BHP Billiton has a reason to be above its current price point.