Iron ore bust

BHP Billiton Limited (BHP) discovers, acquires, develops, and markets natural resources worldwide. It was founded in 1851 and is based in Melbourne, Australia. BHP operates through four segments: Petroleum, copper, iron ore and coal. Iron ore constitutes 38% of its revenue. BHP has enjoyed an overly positive growth rate due to the worldwide demand for iron ore for the production of steel. However, due to the sluggish price of iron ore, BHP’s recent positive run could be coming to an end and it looks to be ready to short.

BHP had reported significant and robust growth for the six months ending June 30, 2017, which was responsible for an increase of 13.4% in BHP shares. Contributing to this upbeat trend were productivity gains of $12 billion and a significant reduction of capital exploration expenses in its onshore plans. In its fiscal year 2017, BHP reduced capital exploration expenses by $5.2 billion resulting in a 32% plunge in total expenses.

Such momentum is simply unsustainable, due to its massive iron ore interests the price of which have fallen sharply. Mining companies continue to produce more supply, while inventory has significantly increased as a direct result of China’s demand for iron ore. Specifically, BHP anticipates iron-ore productivity to be within 239-243 million tons in fiscal year 2018, representing year-over-year upside of 3% to 5%. Improved productivity will come on the back of an increased yield of the Western Australia iron ore mine. Quite simply, iron ore prices are in a bear market, with volatility paving the way with prices reaching a high of $95 per ton in Feb 2017, then failing to $53 per ton in June 2017.

Additionally, metal commodities’ price fallout will adversely affect BHP’s dividend policy. BHP’s dividend policy differs from other companies where payouts are based on 50% of its cash flow rather than to a flat dividend payment in each quarter. Its recent dividend payment is 43¢ per share (including a 33¢ per share minimum payment plus an additional 10¢). This phenomenon cannot be repeated in upcoming quarters.

TECHNICAL PICTURE
BHP rebounded sharply from a death cross pattern in June thanks to its positive growth report, productivity gains, and China’s Belt and Road initiative resulting in up to 150 million tons of additional steel demand which drove up demand for raw materials. This all led to its sharp upward reversal from $33. However, increased production has led to a drop in iron ore prices and the formation of double top in BHP around $44. A correction should test support at $40 from the September low and a gap around $38.50. If that support is taken out, BHP could test its June lows. BHP is a shining candidate for a short position.