BHP Billiton's Diversification Strategy Works for Stockholders

by Tony D'Altorio

BHP Billiton's Diversification Strategy Works for Stockholders

by Tony D'Altorio, Investment U Research

Tuesday, September 14, 2010

BHP Billiton ADR (NYSE: BHP), the world's biggest mining company, certainly has made the financial news a lot lately.

Some of the more recent articles have focused on its efforts against the additional tax that Australia's new government wants to impose on miners. Others highlight BHP's recently launched, $39 billion takeover offer for the world's largest producer of potash, Potash Corporation of Saskatchewan (NYSE: POT).

BHP has strong backing for its bid, thanks to its strong showing in the fiscal year ending June 30, 2010. During that time, its annual pre-tax profits rose nearly 70% to $19.6 billion on revenues of $52.8 billion

It also made annual profit margins of 38%, with annual cash flows that are five times higher than net debt.

The company's latest earnings report highlights its noteworthy corporate strategy based on diversification across a range of commodities. BHP currently has nine divisions: iron ore, base metals, energy coal, metallurgical coal, petroleum, manganese, aluminum, stainless steel materials (nickel), and diamonds and specialty products.

Its management team continues to translate that goal into practice, producing favorable results for stockholders. Their strategy works nicely, as relative strength in some commodities compensates for weakness in others.

And BHP wants to reach even further with a tenth division devoted to potash.

Diversification the BHP Billiton Way

Over the last year, iron ore boosted BHP Billiton's profits the most. The commodity contributed $6 billion of the $19.6 billion of the company's profits.

While it made just under that last year on iron ore, the division should make more going forward.

BHP pioneered the move in iron ore pricing from negotiated annual contracts to quarterly spot market-based prices. And spot prices currently sit at about $140 a ton, compared to only $60 a ton just before the new system took over.

Ranking second in profits, BHP's base metals division beat out metallurgical coal, which saw a strong 2009 but a far weaker 2010.

Buoyant copper prices especially yielded $4.6 billion in earnings before interest and tax. That marked a sharp rise from the $1.2 billion the division made last year when copper prices collapsed thanks to the financial crisis.

Additionally, the company's oil and gas division bolstered its bottom line. With a major presence in both - something no other mining company can claim - BHP added $4.6 billion to its earnings.

BHP Has a Lot Going Forward

A closer look at BHP Billiton shows ebbs and flows across its nine divisions. But in the end, they roughly balanced each other out over the past two years, despite the extremely volatile commodities markets.

Revenues during that time remained stable between $50.2 and $52.8 billion. Earnings before interest and tax and excluding one-off items also stayed about the same, rising from $18.2 billion to $19.7 billion.

BHP even paid down its net debt, which fell by $2.3 billion to a mere $3.3 billion. Its gearing ratio - a measure of debt versus capital - fell to only 6%, the lowest in the mining industry so far.

(As many investors now know, the less debt a company has, the better its long-term health prospects.)

Meanwhile, company cash rose $1.7 billion to $12.5 billion from June 2009 to June 2010. It's no wonder that bankers seem so eager to extend $45 billion in syndicated loans to finance BHP's Potash deal.

Move Away From Industrial Metals

If BHP Billiton succeeds in its Potash bid, it would move the company even further away from industrial metals. Agricultural fertilizers track completely different economic cycles than do iron ore, copper and aluminum, which largely follow manufacturing activity.

BHP has staked $39 billion on the new commodity. And based on its track record, investors would be wise to bet the same way.

The company's CEO, Marius Kloppers, says, "We are interested in commodities with different growth profiles, [whose prices] kick in at different stages of the economic cycle."

So even if it doesn't succeed with Potash, expect BHP to continue looking around. Kloppers adds, "As a shareholder, you should only want the most diversified exposure."

That might not be true with every other company, but BHP does it well. Its diversification strategy works beautifully and stockholders can only benefit.

Investors don't need to go digging on this one.

Good investing,

Tony D'Altorio

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