A third stock purchase this month. Woo-hoo! I didn't plan on any more buying activity after the initiation of a position in National Oilwell Varco, Inc. (NOV), which came not long after adding to my position in Unilever PLC (UL). October was a bit busier than usual for me in regards to capital allocation, and I dipped into my emergency fund to cover some of that activity. Maybe buying high-quality stocks at attractive valuations isan emergency?
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Anyway, I realized I had to simultaneously build the emergency fund back up while also deploying capital to the portfolio. Not an easy task, but first world problems aren't really all that difficult. However, this most recent purchase means the emergency fund will have to remain a tad dry for now.
I don't often catch stocks at or near their 52-week lows, as I make no attempts to time the market or individual stocks and their prices. But I did perhaps catch some luck with this most recent transaction, buying shares just a few pennies above their yearly low.
I purchased 20 shares of BHP Billiton PCL (BBL) on 11/20/14 for $50.20 per share.
BHP Billiton Plc is the world's largest diversified resources company. They're engaged in the exploration, development, processing, and production of a number of minerals. They also have a substantial oil & gas business.
The company operates in five segments: Iron Ore (32% of fiscal year 2014 revenue); Petroleum and Potash (22%); Copper (21%); Coal (14%); and Aluminum, Manganese, and Nickel (13%).
Their production operations are located primarily in Australia, the Americas, and southern Africa. They have a workforce of approximately 123,800 employees and contractors at 130 locations in 21 countries.
This is a dual listed company structure. They have two parent companies - BHP Billiton Limited and BHP Billiton PLC - that operate as a single economic entity, run by a unified management team. The company is headquartered in Australia. This article is referencing the BBL shares that trade on the London Stock Exchange and are offered as ADR (American Depository Receipt) shares on the New York Stock Exchange for US investors. One can also purchase the BHP shares which trade on the Australian Securities Exchange, which are also offered as ADRs. Since the BBL shares trade in the UK, the dividends they pay are not taxed by a foreign government due to a tax treaty between the US and the UK.
I just discussed BBL's fundamentals last month after buying up shares in the company, so I won't rehash that information for you here. But I think you'll find double-digit compound annual EPS growth and near-double-digit revenue growth over the last decade pretty attractive.
What's changed since I added to my position last month?
Not much of anything, other than the fact that I could buy shares about 5% cheaper. If I liked BBL at near $53, why wouldn't I like it even more at near $50? As such, I took this opportunity to average down further.
So I maintain conviction here in this high-quality company and their ability to grow their profits and dividends over a long period of time. Commodities can be volatile, and Billiton's business is cyclical. But as a long-term investor looking out over the next couple of decades and beyond, I think the future me will be very glad the me of today bought here at near $50.
For any interested shareholders or potential investors, the company released a presentation yesterday. It goes over some of the divestment plans, increased productivity, and reduced expenditures. Simultaneously reducing capital expenditures and improving productivity should result in increased free cash flow, even while commodities like iron ore remain weak here.
One interesting aspect of the upcoming demerger is that BBL will maintain its current dividend, implying a higher payout ratio with a smaller asset base to propel profit. Not only that, but there's the potential for a dividend payout from the new company as well. This is of course simply speculation, but there is a chance for both companies to pay out a dividend after the demerger is complete. In addition to the dividend, there's a chance for unlocked value, as it appears to me that the market is basically pricing this new company at a value of $0.
BBL's shares yield 4.94% here, which is obviously an extremely attractive yield in this market. Factor in the potential growth of the dividend over the long haul, BBL's high-grade assets, worldwide geographical exposure, and operational excellence, and the investment thesis becomes pretty clear. I think the downside is a lot more limited than the upside here, and a yield near 5% pays me handsomely and generously to wait for conditions to improve. The hefty dividend is well-supported by a payout ratio of 47.9%, which should give them room to continue to increase the dividend even while commodities like iron ore and oil are weak, and the demerger of a small piece of the company is eventually executed.
I pointed out some of their risks last month, which obviously remain the same. Primarily, you have exposure to a highly cyclical base of commodities. Price swings, like we've seen with iron ore and oil this year, can have a dramatic effect on the company's profitability, its stock price, and possibly even its ability to pay and grow its dividend. There's also geopolitical risk to factor in; however, the company primarily operates in countries with very stable governments. Lastly, BBL lacks any kind of real pricing power, which limits its ability somewhat to control its own destiny.
My opinion on the valuation of shares in BBL hasn't changed materially in the last month as nothing has fundamentally changed with the company over that time frame. Shares currently trade hands for a P/E ratio of 9.69, which is almost half that of the broader market. It's also much lower than BBL's five-year average P/E ratio of 14.
I valued shares using a dividend discount model analysis with the same input as last month - a 10% discount rate and 5.5% long-term growth rate. This growth rate seems reasonable considering it's about half of BBL's 10-year EPS growth rate. I purposely use fairly conservative numbers with more uncertain investments like BBL due to the volatile nature of commodities. However, even using this conservative valuation model I still get a fair value of $58.14. That means shares potentially offer a 15% margin of safety even after factoring in somewhat low growth, which indicates to me that shares are a value here.
BHP Billiton remains the world's largest and arguably best diversified natural resource company. Mr. Market's irrational pricing hasn't changed that, but it has created an opportunity. Their broad exposure to a number of resources that the world requires for civilization as we know it puts them in a position where long-term success is highly likely. The short term could remain rocky, but I can't imagine that buying BBL at $50 here will turn out to be a poor long-term investment. However, anything is possible, which is why I maintain a diversified portfolio.
This purchase adds $49.60 to my annual dividend income, based on the current $1.24 semi-annual dividend.
I'm going to include a couple of other valuation opinions below, as I use these to concentrate my reasonable valuation estimate:
Morningstar rates BBL as a 4/5 star value, with a fair value estimate of $70.00.
S&P Capital IQ rates BBL as a 4/5 star "buy", with a 12-month target price of $59.00.
I'll update my Freedom Fund in early December to reflect this recent purchase.
Full Disclosure: Long NOV and BBL.
What are your thoughts on BBL? Does this seem like a good value right now?
Thanks for reading.
This article first appeared on GuruFocus.