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BHP Billiton Comes Face-to-Face with Volatile Commodity Markets

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Mar. 8 2016, Updated 12:05 p.m. ET

Acquisition opportunities

Many times during the earnings call, BHP Billiton’s (BHP) (BBL) management talked about opportunities available at the bottom of the cycle. The capital expenditure cut of $3.5 billion, the dividend cut of ~$6 billion, and cost outs should net BHP $10 billion in cash savings. It should place BHP in a comfortable position in order to pursue any accretive deals in the market.

BHP sees value in copper and oil in the longer term, so it might prefer deals in this space. Any value-accretive deals should be viewed positively by the market.

BHP, however, didn’t outline any strategy to grow its production, which might be a negative. Its growth pipeline is weaker than its nearest peer, Rio Tinto (RIO).

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Concerns remain on demand side

BHP concurs with the consensus market view that weak demand growth in China is more of a structural issue. They believe it’s driven by a shift from an investment-based economy to one driven by consumption and services. This should keep a lid on commodity prices in the short to medium term, which will negatively impact BHP’s profitability.

As you can see in the above graph, prices for all of BHP’s commodities, including iron ore, coal, copper, and oil, are under pressure. This downturn is unprecedented in magnitude as far as the majority of BHP’s commodities are concerned. It’s also unprecedented in its nature, which seems more structural to an extent.

This is also impacting BHP’s peers such as Freeport-McMoRan (FCX), Alcoa (AA), Rio Tinto (RIO), Vale SA (VALE), and Cliffs Natural Resources (CLF).

BHP’s outlook

In the short term, there’s no expectation for more rebound in commodity prices. The dividend cut might keep income-seeking investors at bay. This might mean a short-term to medium-term pressure on prices. In the long term, however, higher free cash flows and accretive acquisitions could turn investor attention to BHP stock.

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.

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