Trade wars are wealth destroyers. The longer these disputes continue and the more actions governments take, the greater the danger of severe damage to the economy and stock market, explains Roger Conrad, global investing expert and editor of Conrad's Utility Investor.
There are, however, a handful of companies in position to actually win from this worst case. One of them is BHP Group (BHP), the world’s largest diversified mining company, with output focused on a “core four” of copper, oil, iron ore and coal, particularly of the steel making variety.
As an investor, I’ve been drawn to BHP since the 1990s for its unmatched size, resource diversification, global reach and balance sheet strength, showcased by an A credit rating from S&P. These strengths have enabled the company to consistently emerge from violent commodity price cycles with improved market position.
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BHP expects to generate nearly $13 billion in free cash flow this year, after spending nearly $7 billion on mine development. That follows a total of nearly $25 billion over the previous two years, or 2.4 times what it paid in semi-annual dividends. By comparison, total debt is a little less than $33 billion.
Another of BHP’s underlying strengths is having arguably the world’s best “undeveloped” resources. These enable management to ramp up output without making acquisitions, or launching new development in riskier environments.
Meanwhile, the stock is cheap, selling for just 13.7 times expected 2019 earnings. In fact, the NYSE-listed American Depositary Receipt is priced 25 percent below its level of five years ago. And its price to cash flow multiple of 7.5 times is just 40 percent of what it was in early 2010.
Superior long-term staying power selling at a low valuation is enough reason for investors lacking minerals and mining exposure to buy BHP. But there’s also a powerful potential near-term driver of returns: China.
The world’s most populous country and second largest economy is by far BHP’s most important market, generating more than half of last year’s revenue. Concerns about China's economy have grown as the US has raised tariffs, and taken punitive actions against Huawei and other Chinese “national champions.”
That in turn has fueled worries about the ability of the global economy to hold up. And it’s put downward pressure on prices of major commodities like copper.
Iron ore has been the exception, due mainly to a supply shortage brought on by mine closures in Brazil by Vale SA (VALE). That company has been forced to take 5 percent of global production capacity offline this year.
That followed the bursting of a mine-related dam in January, prompting crackdown by the authorities. Worse, management guidance is it may take two years for output to fully recover.
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While supplies are constrained, China is stepping up imports of a raft of key resources, from iron ore and metallurgical coal to copper. The reason: US trade tensions are threatening the country’s export industries as well as its plans to shift to a more consumer-based economy. That’s forced the government to increasingly rely on the “old” China economy of housing and infrastructure building.
Heavy investment in these sectors was key to avoiding the worst of the 2008-09 global financial crisis. Now China is ramping up activity again to blunt fallout from fraying US relations.
Rising Chinese resource imports is very bullish for BHP’s bottom line for both demand and price, particularly combined with supply pressures in iron ore and copper. Supplies of the red metal are also pressured, as current prices are not high enough to encourage sufficient new investment. That too means more demand and a higher price for what BHP produces.
The best case for the global economy is an amicable resolution of US/China trade tensions, allowing both countries to keep growing and powering the rest of the world. That’s also the best case for BHP, as it means more demand and higher prices for commodities.
What makes the company unique, however, is it can prosper even if the trade dispute between the US and China escalates. Buy BHP below our recommended entry point of $55.
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