BHP Billiton plc

What’s Up with BHP Billiton Plc (ADR) BBL

February 14th, 2013 Posted by Investment Valuation No Comment yet

BHP, formerly known as BHP Billiton Plc (ADR), is the trading entity of BHP Group Limited and BHP Group plc, Anglo-Australian multinational mining, metals, and petroleum dual-listed public company headquartered in Melbourne, Victoria, Australia. From Wikipedia

BHP Value Investing Approach   

This model is prepared in a very simple and easy way to value a company, it adopts the investment style of the Father of Value Investing Benjamin Graham. The essence is that any investment should be purchased at a discount. In other words, the true value should be more than the market value. Graham believed in fundamental analysis and was looking for companies with a sound balance sheet and with little debt. The basis for this valuation is the company’s five years of historical financial records, the balance sheet, income statement, and cash flow statement. We calculated first the enterprise value as our first step. We believed this is important because it measures the total value of the company.

BHP Investment in Enterprise Value  

The concept of enterprise value is to calculate what it would cost to purchase an entire business. Enterprise  Value (EV) is the present value of the entire company.  Market capitalization is the total value of the company’s equity shares. In essence, it is a company’s theoretical takeover price, because the buyer would have to buy all of the stock and pay off existing debt, and taking any remaining cash. 

Enterprise Value = Market Capitalization + Total Debt – (Cash and Cash Equivalent + Short Term Investment)
BBL EV
The market capitalization was erratic in movement. Total debt was 9.5 percent, while cash and cash equivalent were 4 percent of the enterprise value, thus enterprise value was 5.5 percent over against the market capitalization. Buying the entire business of BHP is paying 5.5 percent of its total debt and 94.5 percent of its equity. The cash per share was $2.88 average.

The purchase price to date, February 11, 2013, would be $202 billion at $75.54 per share.  The market price to date was $68.08 per share.

Stock Test by Benjamin Graham

Net Current Asset Value (NCAV) Method

Studies have all shown that the Net Current Asset Value (NCAV) method of selecting stocks has outperformed the market significantly.

The reason for this is when a stock is trading below the Net Current Asset Value Per Share, they are essentially trading below the company’s liquidation value and therefore, the stock was trading at a bargain, and it is worth buying.

Primarily, the concept of this method is to identify stocks trading at a discount to the company’s Net Current Asset Value per Share, specifically two-thirds or 66 percent of net current asset value. 

BBL NCAVPS

Explanation

The net current asset value approach tells us that the stock of BBL was trading at an overvalued price from 2008 to the trailing twelve months. The 66 percent ratio represents only 2 percent of the market value per share. The net current asset value was negative during 2012 and the trailing twelve months.

It shows that the stock of BHP did not pass the stock test because the price was expensive and was trading above the liquidation value of the company.

Market Capitalization/Net Current Asset Value (MC/NCAV) Valuation    

By calculating market capitalization over the net current asset value of the company, we will know if the stock is trading over or undervalued. The result should be less than 1.2 ratios.

Formula: Market Capitalization / NCAV = Result (must be lesser than 1.2)  

BBL MC NCAV

The MC/NCAV valuation shows that the stock of BHP was trading at an overvalued price from 2008 to the trailing twelve months because the ratio was more than 1.2 ratios.

The margin of Safety (MOS)  

 In my calculation, I used the enterprise value because it takes into account the balance sheet so it is a much more accurate measure of the company’s true market value than market capitalization.

BBL MOS

Explanation

The margin of safety for BHP was 63 percent average which is equivalent to $246. The enterprise value was 21 percent of the intrinsic value.  There was the margin of safety from 2008 to the trailing twelve months except in 2009 where there was zero margin of safety.  The formula for intrinsic value was:

Intrinsic Value = Current Earnings x (9 + 2 x Sustainable Growth Rate)    

The explanation in the calculation of intrinsic value was as follows:

EPS or the company’s last 12-month earnings per share; G as the company’s long-term (five years) sustainable growth estimate;  9 is the constant that represents the appropriate P-E ratio for a no-growth company as proposed, and 2 for the average yield of high-grade corporate bonds.

BBL IV

Explanation

BHP Billiton plc (ADR) marked an intrinsic value averaging to $306, decreased by 93 percent in 2009 and went up by 530 percent the following year. While the sustainable growth rate was 20.69 percent and the annual growth rate was 50.38 percent average. The earning per share was $5.39 average.

The formula for earning per share was:

    EPS

Sustainable Growth Rate (SGR)

Sustainable growth rate (SGR), on the other hand, shows how fast a company can grow using internally generated assets without issuing additional debt or equity. To calculate the sustainable growth rate for a company, you need to know its return on equity (ROE). You also need to know the dividend payout ratio. From there, multiply the company’s ROE by its plow back ratio, which is equal to 1 minus the dividend payout ratio. Sustainable growth rate = ROE x (1 – dividend payout ratio)

BBL SGR

Explanation

The average return on equity was 31 percent from 2008 for BHP, while the payout ratio was 38.68 percent average. ROE was low at 15.01 percent during 2009 but the payout ratio was high at 77.8 percent.

Moving forward, Return on Equity (ROE) is an indicator of company’s profitability by measuring how much profit the company generates with the money invested by common stock owners. For us to calculate for ROE, we would use this formula:

      ROE

Return on Equity also shows how many dollars of earnings result from each dollar of equity.

Relative and Average Approach

BBL Relative

Relative and Average approach produced almost the same results. For the return on equity, the average result is greater by 2 percent because it took into account the previous period’s performance.

BBL Graph

Explanation

As we can see, the line of intrinsic value in 2009 slope downward by 93 percent from 2008, then it dropped down below zero, for margin of safety. Then it slowly rose up by 530 percent the following period of 2010, until it reached its peak of $684 at 228 percent trend, then sloping downward again in 2012 at -66 percent. What does this mean?

The intrinsic value is the true value of the stocks of BHP. The line shows how the true value of the stock trends in the market. On the other hand, the enterprise value is the market value of the stock. I have used the enterprise value rather than the market value because, in my own discretion, it is more accurate to use because it factors the total debt and cash of the company, in which buying the whole company, you have to acquire also its debt and pocket the cash. Enterprise value was stable below $100.

The margin of safety is the space between the two lines. If we have to calculate the margin of safety we get the difference between the enterprise value and the intrinsic value.  For BHP, the average margin of safety from 2008 was 63 percent.

Price to Earnings/Earning Per Share (P/E*EPS)      

This valuation will determine whether the stock is undervalued or overvalued by multiplying the Price to Earnings (P/E) ratio with the company’s relative Earning per Share (EPS) and comparing it to the enterprise value per share. From there, we can determine the status of the stock price.

BBL PE EPS

Explanation

The relative valuation for P/E*EPS shows an overvalued price from 2008 except in 2011. The stock was trading at an overvalued price because the price was greater than the P/E*EPS ratio.

The enterprise value was 116 percent of the P/E*EPS ratio, therefore, overall, the stock price was overvalued by 16 percent, thus the price was considered expensive.

In my computation above I have used the relative approach in the P/E*EPS ratio. There is another way of computing this valuation and that is the average approach. In the relative approach, we consider the prior year performance of the company and that is the 2007 performance in the price to earnings ratio. In the table below, you will find out the difference between doing these two approaches.

BBL Relative PE

The table shows that using the average approach produced a higher result of P/E*EPS ratio.

The Enterprise value (EV)/Earning Per Share (EPS) or (EV/EPS) 

The use of this ratio is to separate price and earnings in the enterprise value dividing the enterprise value of projected earnings (EPS).  The result represents the price (P/E) and the difference represents the earnings (EPS).

BBL EV EPS

The relative valuation for EV/EPS tells us that the price (P/E) was 23 percent average from 2008. While the remaining 77 percent represents the earnings (EPS). But as mentioned, this valuation depends on the analyst’s own discretion.

Enterprise Value (EV)/ Earnings Before Interest, Tax, Depreciation, and Amortization (EBITDA) or (EV/EBITDA).   

This metric is used in estimating business valuation.  It compares the value of the company inclusive of debt and other liabilities to the actual cash earnings exclusive of non-cash expenses. This metric is useful for analyzing and comparing profitability between companies and industries.  It gives us an idea of how long it would take the earnings of the company to pay off the price of buying the entire business, including debt.

BBL EV EBITDA

Explanation

The EV/EBITDA tells us that it will take 7 years to wait to cover the costs of buying the entire business of BHP.  In other words, it tells us that it will take 7 times of the cash earnings of BBL to completely cover the costs of purchasing the entire business of the company. This valuation shows the cash earnings of the company in relation to the enterprise value or market value. The EBITDA represents 15 percent of the enterprise value.

The EV/EBITDA shows the profitability of the company with regards to its cash earnings compared to the market price. It shows how long will the buyer is willing to wait to cover the costs of buying the entire business.

In conclusion,

The market capitalization of BHP is trending erratic. The total debt represents 9.5 percent of the enterprise value, while cash and cash equivalent represent 4 percent, thus buying the entire business would be paying 5.5 percent of total debt and 94.5 percent of equity. The total cash per share was $2.88 average.

The purchase price to date, February 11, 2013, would be $202 billion at $75.54 per share. The market price to date was $68.08 per share.

Net Current Asset Value

On the other hand, the net current asset value approach shows an overvalued price from 2008 to the trailing twelve months. Since the stock was trading above the liquidation value of the company.  While the MC/NCAV approach shows an overvalued price since the ratio exceeded the 1.2 ratios. 

Further, the margin of safety tells us that the average margin of safety was 63 percent. Looking at the growth of the company, it shows that the sustainable growth rate of BBL was 20.69 percent average, and the annual growth rate was 50.78 percent average.  While the return on equity shows a 30.71 percent average from 2008.  The intrinsic value was $306 average.

P/E*EPS Valuation

Furthermore, the price was overvalued. Since the average price was 116 percent against the P/E*EPS ratio. This price is overvalued by a 16 percent average. While the EV/EPS shows that the price (P/E) was 23 percent and the earnings (EPS) was 77 percent average. Although the result of this valuation depends upon the analyst’s own discretion.

EV/EBITDA Valuation

The EV/EBITDA valuation tells us that it will take 7 years to cover the cost of buying the entire business. In other words, it will take 7 years for the cash earnings to cover the purchase price for the entire company. The EBITDA represents 15 percent of the enterprise value.

There was a margin of safety of an average 63 percent, it tells us that there is safety in buying. In addition, BHP has a fair return on equity of 30.71 percent average. Moreover, a fair net margin of 23 percent average. Therefore, I recommend a BUY in the stock of BHP Billiton plc ADR.

A note to the reader: These calculations were made on February 11, 2013. These ratios and recommendations are good only until there are changes in the market price. Thank you for reading.

Research and Written by Cris
Interested to learn more about the company? Here’s investment guide for a quick view, company research to know more of its background and history; and value investing guide for the financial status.

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