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Trader Talk is produced by a team of active traders, analysts and various derivatives professionals from multiple organisations. Trader Talk provides comment on equities, commodities, and other financial instruments based on both technical and fundamental analysis.
Unearth the value in BHP BillitonSeptember 20 2014, 7:00am
It has been a cautious week for equities as investors digested disappointing comments from the OECD and awaited the outcome of several key risk events, including the referendum on Scottish independence and the US Federal Reserve policy meeting.
The Organisation for Economic Co-operation and Development slashed its growth forecasts for major developed economies, urging more aggressive stimulus to ward off the risk of deflation in a subdued Eurozone. The OECD projected the Eurozone would only grow by 0.8% this year and by 1.1% in 2015, a sizeable downgrade from its projections in May, when the Paris-based organisation forecast growth of 1.2% and 1.7% respectively.
The IMF also warned that the global recovery is on precarious footing, as rising geopolitical tensions and the prospect of tighter monetary policy in the US risk dampening the outlook for global growth. The Fund signalled it is likely to cut its next batch of forecasts which will be released in October.
Official data showed China’s factory output growing at its slowest pace since December 2008, while industrial production expanded by 6.9% in the year to August, down from the 9% growth recorded in July. The data suggests the world’s second largest economy may miss the official 7.5% GDP target, although China’s central bank reacted by injecting a combined 500 billion yuan of liquidity into the country’s top banks. Analysts say the amount is equivalent to a 50-basis point cut to banks’ reserve requirement ratio and illustrates the People’s Bank of China’s willingness to use targeted measures to stimulate the economy.
Meanwhile, US industrial production also fell 0.1% in August, the first decline in seven months, although analysts said the fall was caused by problems seasonally adjusting auto production. Third quarter GDP looks to be on course for another strong reading, heightening speculation that the Federal Reserve will hint that interest rates might be raised sooner than expected.
The Fed, however, repeated its assurance that rates would stay ultra-low for a “considerable time” after a bond-buying stimulus programme wraps up. The committee announced a further $10 billion reduction in its monthly purchases, leaving the programme on course to close next month, although it said “significant” slack remains in the labour market, a further sign it is in no rush to raise benchmark borrowing costs.
Domestic markets have been under pressure due to the uncertainty in the lead up to the Scottish referendum. According to bookmakers, the “NO” vote was always the most likely outcome, but equities recovered after the vote as the downside risk to UK growth has been lifted. The recent fall in Sterling should also benefit many listed companies as the UK derives almost 75% of total sales, revenues and profits from overseas, so a weak domestic currency will improve margins.
Technical analysis of the FTSE 100 depicts the recent uncertainty, with the index drifting lower over the past two weeks. The 50-day moving average appears to be attracting support at 6780, as the oscillators near oversold territory, suggesting the blue-chips may not fall much further. Additional support is seen at 6695, while a move back above 6850 should reinvigorate the bulls.
In conclusion, it has been a week of uncertainty and low volumes, but with this week’s risk events behind us, markets should be able to claw back some of the recent loses. Central banks remain accommodative, fuelling liquidity in equity markets for the foreseeable future.
Commodities benefited from the stimulus in China, with Brent Crude Oil, copper and iron-ore recovering from recent lows, helping the mining sector level-off after a period of weakness. BHP Billiton (Epic: BLT), the world’s largest mining group, has fallen 14% over the last month as a result of global growth concerns and after announcing plans to demerge assets.
The company is reliant on continued growth in China, the world’s largest user of iron-ore, so this weeks targeted measures designed to maintain annual GDP growth of 7.5%, should underpin demand for materials.
The chart of Billiton illustrates the recent fall, with shares nearing major historic support at 1800p. Meanwhile, the oscillators appear to be bottoming-out in acutely overbought territory, with the RSI at its lowest level since July 2011, indicating a turnaround could be imminent.
The Anglo-Australian miner, which was formed through the merger of BHP and Billiton, announced it would demerge a lot of the original Billiton parts, including aluminium, nickel and manganese. Following the demerger, BHP Billiton will become a more focused group, with iron ore, copper and petroleum making the largest contribution to group operating profit.
Annual profits were bolstered by record iron-ore production, while management expect to increase output again in the current fiscal year. The final dividend was increased 5%, with the shares forecast to yield a twice-covered 4.2% this year.
The company has a strong balance sheet, with recent cost-cutting efforts achieving savings of $5.5 billion so far this year, while production has increased. The miner is also making more cash, which has reduced debt levels, leaving the company free to increase shareholder returns. Analysts also believe assets sales could fund a special dividend payment in the first half of 2015, while other forecast the company will announce between $3 billion and $5 billion in share buybacks next year.
The shares trade on 12x earnings, a slight premium to peers, yet back on technical support, I believe upside should be unlocked from; the demerger, a share buyback and a special dividend. At the time of writing the share price is 1816.5p and a long-trade with a tight stop-loss below support at 1744p offers an attractive risk/reward bias. Near term targets are seen at 1905p, 1978p and 2087p.
This report was written by Mark Allen – Head of Derivatives at Simple Investments Stockbrokers. The writer does not hold a position in BHP Billiton, but client accounts may. The material in this report has come from Simple Investments internal data sources, Simply Charts and BHP Billiton’s corporate website.