Are BHP’s Shares Under-priced?

The shorting is over. Is it time to start buying BHP Billiton [ASX:BHP] again?  A better question might be, could BHP’s share price be near the bottom?

Analysts are starting to feel more positive about BHP. Citigroup have stated BHP is a buy, upgrading their neutral view. Morgan Stanley also believes the big miner might have been oversold.

Morgan Stanley might not think it’s time to buy BHP, but they do believe share prices are close to the bottom. The investment firm has upgraded their view on the big miner to ‘equal-weight’, as opposed to ‘over-weight’.

Despite commodity prices still wavering, BHP’s big short may be over.

BHP is preferred to Rio

Just two weeks into 2016,BHP shares have already dropped 16.40%. It hasn’t been a great start to the year and with commodities wavering things aren’t looking much better.

But Citigroup, with their optimistic outlook, has switched their preference from Rio Tinto [ASX:RIO] to BHP as their favourite miner. As you might expect Rio’s boss, Sam Walsh, doesn’t share Citi’s opinion.

The New Year has been an ugly start for big miners, but as Mr Walsh said in a note to staff, ‘Rio Tinto can thrive when others falter.’ Walsh expects the market carnage to provide an opportunity for Rio to widen the gap between competitors.

Of course Rio’s CEO would make these comments to promote optimism and hope for what will be a tricky year ahead. But this is beside the point. More analysts are looking closer at BHP, trying to predict what will happen next.

Citigroup wrote a note to investors commenting on their shift in views. ‘We switch to preferring BHP over Rio given our bearish iron ore view and 20 percent underperformance over the last 6 months.’ But you might not believe what their target price is.

Citi has set a target price of $18 for their new favourite miner. BHP’s share closed yesterday at $14.88, making a difference of almost 21%. However, Citi has also stated that BHP’s fair value would be closer to $7 per share if spot prices for BHP’s commodities were to continue in the longer term.

BHP’s fall from grace

There are a number of reasons why BHP’s share price has cracked 11 year lows. And the first reason has to do with commodity prices.

It’s no surprise to anyone that commodity prices are falling. But drops in coal and iron ore prices are affecting miners, like BHP, more than ever.  It seems like every day iron ore prices are declining and negatively affecting investors’ views on BHP.

On Wednesday, when iron ore fell below $US40, BHP’s share price dropped below $15 for the first time in 11 years. And this is not a one off occurrence. Every time commodities take a beating, it usually means the same for BHP and other miners.

The second reason is the Samarco costs. BHP’s biggest iron ore mine in Brazil experienced a huge disaster late last year.  The collapsing dams damaged the surrounding communities, while also spreading toxic waste across the countryside.

The costs are close to the $4 billion mark for BHP. And this is just the financial costs. BHP’s net debt is expected to rise about $40 billion by the end of 2017.

The sheer amount of debt is encouraging investors to drive share prices down.  Since the event in November, BHP’s share price has plunged 36%. Granted, the decline is also attributed to falling commodity prices and the fear of dividend cuts, yet the dam disaster has accelerated the situation to help BHP hit 11 year lows.

What to do about BHP shares

Share prices jumped up 5.5% this morning. Commodities rallied overnight, giving relief to energy and mining sectors. It’s also likely that Citi group and Morgan Stanley’s recommendations helped in BHP’s climb.  So does this mean share prices are going to hit the targeted $18?

BHP 15th Jan

Source: Google Finance

Not today, anyway. BHP’s shares have already started to recede from their jump on open. Yet it may be foolish to count BHP out in the long run.

Härje Ronngard,

Junior Analyst, Money Morning

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