BHP Billiton - $80 billion growth plan

Higher commodity prices have filled BHP Billiton (LON:BLT)’s coffers with a monster first half profit of US$10.7 billion. Shareholders will get a US$10 billion capital management plan and an increased dividend but the company has its eyes firmly on the commodity/China boom. It will spend upwards of US$80 billion over the next five years on ‘organic growth projects’. It has the cash flow to do so and with its underlying return on capital of 41%, as a track record, who is going to argue? As cash flow has increased in recent periods, the drums have begun to beat louder for the company to make larger returns to shareholders. It hasn’t helped BHP’s cause that two high profile deals failed to get over the line in the last two years.

 The proposed Pilbara iron ore joint venture with Rio Tinto failed to convince global regulators and the Canadian government took exception to BHP’s attempted acquisition of Potash Corporation. BHP booked a US$314 million pre-tax charge on the latter during the current period. For the whole of calendar 2010 US$700m was spent on deals which didn’t complete.

 The company has, however, always spoken of a wide array of opportunities to invest in organic growth. Suitably chastened by the failed corporate activity, BHP now intends to invest around US$80 billion over the next five years in major projects including iron ore, metallurgical coal and others, several of which are at an advanced stage of approval.

BHP provided an insight into how this investment will be spread across its portfolio. We estimate that about US$25 billion will go into iron ore, US$15 billion into petroleum, US$12 billion towards base metals and US$8 billion in metallurgical coal. The balance of US$20 billion will go towards potash, manganese, stainless steel, aluminium and diamonds. The group also announced an expanded US$10 billion capital management program that will utilise both on-market and off-market share buybacks. The initiative is expected to be completed by the end of calendar 2011 which is a fairly aggressive target.

We think BHP has the balance about right – a heavy skew towards organic investment and growth with a nod towards better returns to shareholders. The only contingency might be the more cautious approach to major acquisitions.

A recent deal appears to bode well, though, with the company paying $4.75bn for Chesapeake Energy’s Fayetteville shale assets. This will boost BHP’s position in shale gas and provide the expertise to identify and develop further assets. A much talked of potential target is Woodside Petroleum; especially as Shell looks likely to sell its stake.

Looking at the H1 results the strong profits performance for the half year was due to the rebound in commodity prices. There is some scope for this boost to continue into 2011 as many commodities, such as copper, hit new highs and others, including iron ore and oil, continue to perform well. Future earnings per share growth will, though, be increasingly driven by production growth and share buy backs.

This report was produced by Senior Research Analyst, Greg Fraser.