Tuesday's results from BHP Billiton(LSE: BLT) showed that the diversified resources company is performing well. It has made improvements not only to its bottom line, but also to its financial strength and cash flow. Its shares have beaten the FTSE 100 by 5% already this year. However, its future performance could be far superior when compared to the wider index. Here's why.
While BHP's first-half results were an improvement on those from the same period a year earlier, it was unlikely they would get any worse. After all, the company reported a loss of over $7bn in the first half of 2015. This time around, it made a profit of over $6bn and seems to be well-positioned to grow its bottom line over the medium term.
To do this, BHP has restructured its asset base so that it now consists of large, long-life and low-cost assets. They have benefitted from a constant drive towards greater efficiency and productivity, which is starting to bear fruit. At the same time, the company has been able to reduce leverage and de-risk its operations. For example, its first-half results showed that net debt fell from $26.1bn in June 2016 to $20.1bn at the end of the most recent period. At a time when interest rates in the US are moving higher, this seems to be a logical move.
In the current financial year, BHP is expected to return to profitability and record earnings of 103.8p per share. This puts it on a forward price-to-earnings (P/E) ratio of 13.5. This may not sound particularly cheap on a standalone basis, but when compared to the company's historic average P/E ratio it indicates there is upward rerating potential. In the last five years, BHP has traded on an average P/E ratio of 20.6. Therefore, a significantly higher rating than that applied by the market at the present time could be on the horizon.
When coupled with its lower risk profile, this indicates that the company is a sound long-term buy. It has a diversified and highly efficient asset base, is now in profit and could grow its earnings at a rapid rate if commodity prices remain robust. As such, further FTSE 100-beating performance could lie ahead.
A better opportunity?
Of course, the resources sector is relatively cheap at the present time, as highlighted by the rating of copper miner KAZ Minerals(LSE: KAZ). It is expected to increase its bottom line by 176% this year and by a further 39% next year. This puts it on a forward P/E ratio of just 8.9. This indicates there is arguably even more upward rerating potential on offer than is the case for BHP. That's especially the case when KAZ has a historic P/E ratio when in profit of 24.8.
However, since BHP has greater diversity and a lower-risk asset base than its resources peer, it seems to be the most enticing purchase based on the risk/reward ratio. However, both stocks look set to outperform the FTSE 100 in 2017.
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Peter Stephens owns shares of BHP Billiton and KAZ Minerals. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.