For capital-intensive companies with different capital structures, it’s appropriate to use EV-to-EBITDA (enterprise value to earnings before interest, taxes, depreciation, and amortization), as it neutralizes the impact of debt structure on valuation.
- BHP Billiton (BHP) (BBL) currently has an EV-to-forward-EBITDA of 7.4x, which is higher than its last five-year average of 6.6x. Rio Tinto (RIO) and Vale SA (VALE) have EV-to-EBITDA of 8.2x and 7.4x, respectively.
- In the last five years, BHP’s trading range has been between 4.8x and 8.8x.
- Since the start of 2015, BHP’s EBITDA estimates have been revised downward 25%. The downgrade is mainly due to lower commodity price assumptions. The downgrade to earnings has been the major reason BHP’s valuation multiple has increased from 6.3x at the beginning of the year to the current 7.4x.
- BHP’s cost out and productivity enhancement program should help its valuation going forward. However, any unexpected downgrade to commodity prices due to a prolonged weakness in China or any other catalyst would be negative for BHP as for other miners, including RIO, Vale, and Cliffs Natural Resources (CLF).
- In the meantime, an all-time high and impressive dividend yield close to 7% is keeping income-seeking investors interested in BHP at this stage of the market downturn.
While there are near-to-medium term pressures for weaker iron ore and oil prices, BHP’s long-term fundamentals are in order. As we’ve already seen, cost out and debt reduction are going on as planned. With low-cost and high-quality assets, BHP is well equipped to cope with the falling commodity price environment. Its capital expenditure of $8.5 billion for fiscal 2016 and $7 billion for fiscal 2017 has unapproved capex (capital expenditures), which provides the company with additional flexibility in case things take a turn for the worse.
The SPDR S&P Metals and Mining ETF (XME) invests in the metals and mining sector, so it provides diversified exposure to these companies. CLF forms 3.9% of XME’s holdings.