China may hold BHP profit key

Like me, I'm sure you have all been inundated by the media hype surrounding BHP's report last week.

However, it would be amiss of Taking Stock to not at least mention a few points of conjecture that have been circulating the airwaves lately.

As I have been highlighting for some time now, the global backdrop for BHP's operations has been one of weakening economic growth, softening commodity demand and falling commodity prices.

This is a key factor that needs to be kept in mind when assessing its performance.

Secondly, a lot comes down to whether you are a long-term bull or a bear on China as to how you perceive the recent report and outlook.

The sheer size of the numbers reported by BHP are so large that they almost feel beyond comprehension, and certainly one would think that a company that has a 12-month net profit of $US 15.417 billion must be doing pretty well.

This would be the case if not the fact that it is down 34.8 per cent compared to the previous year.

So whether the company is BHP or not, when earnings are trending down and the company's chief executive Marius Kloppers is stating that they expect further short-term economic and commodity market volatility (weakness), most people involved in any type of business would understand and expect a reduction in spending.

We therefore wonder why there is so much surprise, political rambling and media negativity when BHP announced placing several large Australian projects on hold (or possibly scrapping) when the writing has been on the wall way before this report?

Put simply, BHP is an international company that now views Australia as a very expensive place to do business in.

There are many reasons for this that have been mentioned in Taking Stock previously, however, a few points of interest from the company report highlight its dilemma:

·Cash flows have fallen to the extent that the company is now borrowing to fund the gap between its operating cash flows, its spending and its dividends;

·BHP spent almost $10 billion doing a share buyback of its stock at $40.85, which is a huge loss to the company when it is now trading at about $33 and has been lower;

·The Olympic Dam project (a flagship mine) is a much more complex project than initially expected, which would also mean more costly;

·No new projects will get approval in FY13;

·There is the possibility of further write downs on the shale gas purchases in the US; and

·Focus on further development of its highest profit commodities of iron ore, copper and coal but no further expansion on nickel and aluminium.

Despite all the negative attention, it should be noted that since the global financial crisis, BHP has performed better than most of its counterparts.

With the company's enormous diversification and massive cash flow, it is in a stronger position to offset the forecasted lower commodity prices.

Mr Kloppers highlighted this when he stated that he expects the core products volumes to increase by 10 per cent over the next two years.

Information contained in this article does not consider your personal circumstances. You should consult a stockbroking professional before making any investment decisions. Sentinel may hold positions in stocks discussed from time to time.