Saturday, December 6, 2014

My Black Friday Purchase

Talk about Black Friday specials!
Some of my favorite dividend growth stocks in the energy space were down huge this past Friday, with some stocks that I personally track down near 10%. Exxon Mobil Corporation (XOM) was down 4.17%. Chevron Corporation (CVX) was down 5.42%. My recent investment in National Oilwell Varco, Inc. (NOV) looks foolishly timed – its stock was slashed by 5.96%. But you know what that is? That’s music to a long-term investor’s ears.
I believe there’s just a supply-and-demand issue at play here, but the recent OPEC meeting where it was decided that members would not cut production to curb a rather rapid fall in oil prices certainly caused some extra volatility.
At any rate, it’s just business as usual for me. I’ve always said that volatility is another word for opportunity, so an extra-volatile day like we saw two days ago was a rather large opportunity. And I took that opportunity to once again add shares to the world’s largest miner, where a lot of my attention has been focused lately due to what I perceive to be strong value in its shares.
I purchased 25 shares of BHP Billiton PLC (BBL) on 11/28/14 for $47.33 per share.

Overview

BHP Billiton Plc is the world’s largest diversified resources company. They’re engaged in the exploration, development, processing, and production of a number of minerals. They also have a substantial oil & gas business.
The company operates in five segments: Iron Ore (32% of fiscal year 2014 revenue); Petroleum and Potash (22%); Copper (21%); Coal (14%); and Aluminum, Manganese, and Nickel (13%).
Their production operations are located primarily in Australia, the Americas, and southern Africa. They have a workforce of approximately 123,800 employees and contractors at 130 locations in 21 countries.
This is a dual-listed company structure. They have two parent companies – BHP Billiton Limited and BHP Billiton PLC – that operate as a single economic entity, run by a unified management team. The company is headquartered in Australia. This article is referencing the BBL shares that trade on the London Stock Exchange and are offered as ADR (American Depository Receipt) shares on the New York Stock Exchange for US investors. One can also purchase the BHP shares which trade on the Australian Securities Exchange, which are also offered as ADRs. Since the BBL shares trade in the UK, the dividends they pay are not taxed by a foreign government due to a tax treaty between the US and the UK.

Conviction

This post will be rather brief. I discussed at length BBL’s fundamentals when I decided to add to my position in October after a pretty substantial downturn in its stock price (but not the underlying business). I also discussed some recent news regarding the company when I decided to basically triple my position in the company just over a week ago. This most recent transaction has now almost quadrupled the size of my initial investment, and this will probably be the last investment I make in BBL for the foreseeable future due to allocation within the portfolio.
But I think this recent sell-off in energy stocks is an important reminder to always be mindful of why you initially invested in a company. I think when one wakes up to see a substantial number of their investments down by 5% to 10% in one single day, that either elicits joy or fear. If it elicits fear, you may not be fully confident as to why you invested in the the first place. If you feel joyous, as I did, then this is simply an opportunity to buy more shares and more dividend income for the same amount of capital invested. That propels you along the path to financial independence even quicker over the long haul, cheaper stocks being like the turbocharger to your financial independence engine.
BBL shares now yield 5.12%, which isn’t all that far off from what shares offered during the financial crisis. Combine that kind of yield with a five-year dividend growth rate of 10.6% and a low enough payout ratio –47.9% – and you have a recipe for outstanding dividend income and dividend growth.

Risks

I’ve pointed out the risks with this investment a few times now, and they shouldn’t be taken lightly. The prices of the underlying commodities the company controls can change rather quickly, and these changes can have a substantial effect on BHP Billiton’s profitability. These commodities are also cyclical in nature, so there can be years of high or low profits for the company. There’s also geopolitical risk, though I believe this is somewhat low for BBL. Lastly, one should consider competition.

Valuation

So it should be obvious that my opinion on the valuation of BBL’s shares haven’t really changed. Lower oil prices will of course have an effect on the company if these low prices are sustained for a protracted period. However, I think the long-term story is still intact. I suppose it really comes down to whether or not you think the world will demand more energy 10 years from now, and where you think that energy will come from. I think at some point it’s reasonable to expect renewable energy to produce measurable energy for the world, but I happen to think this is still a long way off. Cheaper oil actually has the ironic effect of reducing demand and investment for such energy products. One other note to keep in mind here is that oil only accounts for 20% of the company’s revenue, so it’s somewhat perplexing to me that its shares were even harder hit than some more direct oil plays. Nonetheless, I’m quite happy that was so.
Shares are now trading for a P/E ratio of 9.12 right now. That appears to provide a rather significant margin of safety, especially considering BBL has typically traded for a P/E ratio of 14 over the last five years.
I valued shares using a dividend discount model analysis with a 10% discount rate and a 5.5% long-term growth rate. The growth rate I used for the model is about half of BBL’s growth rate in EPS and its dividend over the last decade. So there’s room for the company’s earnings power to basically halve and still meet the model’s numbers. The DDM analysis gives me a fair value of $58.14.

Conclusion

Fear or greed? It’s up to you how you react when a high-quality company goes on a fire sale. I choose the latter. I’ve been greedy with BBL lately, so I’ll probably have to move on to other opportunities moving forward. But I can’t imagine the me of 2024 will be unhappy that the me of 2014 averaged down on BBL all the way into the $40s.
I think the valuation here is extremely compelling, and perhaps one of the better values in the market. Even my extremely conservative model values shares at a level approximately 25% higher than where shares trade at now. So the company’s growth could be permanently and significantly impaired by 50% (which I don’t believe to be the case), and shares are still cheap.
This purchase adds $62.00 to my annual dividend income, based on the current $1.24 semi-annual dividend.
I’m going to include a couple of other valuation opinions below, as I use these to concentrate my reasonable valuation estimate:
Morningstar rates BBL as a 5/5 star value, with a fair value estimate of $70.00.
S&P Capital IQ rates BBL as a 4/5 star “buy”, with a 12-month target price of $59.00.
Full Disclosure: Long XOM, CVX, NOV, and BBL.

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