Hot Stock
Sydney Morning Herald
Wednesday December 3, 2008
What's new? At last week's annual general meeting in Melbourne, BHP Billiton confirmed Rio Tinto's debt load was the main reason behind the decision to walk away from the takeover offer. With economic and credit conditions highly uncertain, this is a positive outcome for BHP shareholders.
The decision must have been a tough one, given the considerable time and expense put into the bid during the past 12 months, though shareholders should be thankful to see a board acting in their interests. Most boards rate words much higher than actions. The stark contrast between the share price performance of BHP and Rio immediately following BHP's announcement to abandon the bid reflects clearly who would have received the benefit of the takeover: Rio's share price plunged while that of BHP strengthened. Before the offer was withdrawn, the market viewed Rio as the main beneficiary, with BHP's shareholders providing the benefit.The market's response boiled down to balance-sheet strength. Put simply, BHP's is strong and Rio's is weak. This largely stems from Rio's top-of-the-cycle, debt-funded purchase of Alcan for $US38 billion in mid-2007. BHP's decision to walk away last week exposed Rio's fragile balance sheet for all to see. Rio's debt load certainly wasn't a revelation but at some point in the past few weeks it obviously dawned on BHP's board members that "the world has changed". Indeed it has. Debt is now a dirty word. The outlook The decision took the market by surprise but analysts were unanimous in their praise for BHP. As the saying goes, markets make opinions. With this in mind, investors will now focus on what matters most for BHP and that is the market for raw materials, driven by good old economic growth.Given BHP's bid for Rio closely marked the top of the commodity price cycle, it will be interesting to see whether the withdrawal of that bid signifies some sort of bottom. Perhaps that is wishful thinking. Regardless, BHP's strategy of owning long-life, low-cost assets that allows it to turn a profit at all points of the price cycle means that cash flows will remain healthy even in tough times. This could result in the company buying back stock next year once the Rio offer formally ends. Price After touching a low of $20 a few weeks ago, BHP's stock has bounced strongly, surging back higher than $28 following the withdrawal of the Rio bid. After breaking below important support levels of about $35 in September, BHP is now in a consolidation phase. Worth buying? Despite the recent turmoil, BHP remains one of the strongest "large caps" in the world in terms of profitability and financial strength. What other company in the present climate is looking at potentially buying back, instead of issuing, stock? BHP has a robust balance sheet, strong asset base and, from an investor's point of view, compelling valuation. The share price has run hard in recent weeks but buying on a pullback should prove a rewarding exercise.
© 2008 Sydney Morning Herald
Share This