Reading that BHP plans to spend an additional $10 billion, bringing the total to $13 billion, buying back its shares stopped me in my tracks.
Due to the record commodity prices, BHP has been making record profits, $6.2 billion in the last six months of 2006.
A share buyback will not add to shareholder value. Indeed, if I was a shareholder, I'd be taking that extra 5% and selling out, at least that was my gut reaction to the news.
So, lets have a look at BHP.
Market cap - $131 billion
Shares - 2,982 million
P/E - 12.8
EPS - 3.45
Price - $44.03
The EPS works out to a healthy 7.8%. But the earnings are only healthy on the surface. They are based on record prices for aluminum, alumina, copper, iron magnesium and molybdenum. Record prices means the share is at record levels, indeed, just 4 years ago the share price was around $10.
A number of commodity prices have declined. EPS can be expected to decline by 20, 30, 40%. Buying back shares will make it so that there are less shares to average the earnings over, but there will also be less assets being held, less cash. Commodity prices have declined enough, the eps will still decline despite having up to 10% fewer shares to average the earnings over.
The commodity market is cyclic, and buying back your shares when they are premium prices simply rewards those who sell. It does not give share holder value to those who hold. The smart money buys low and sells high. BHP is high.
Just 4 years ago the share price was about $10. How much real value has been added in the way of new properties, new resource, new mines, etc.? I am not sure, but the current price is more than 5 times the book price, and 3.9 times the sales.
The ideal time to buy back shares is when they are priced low, then share holders that stay are rewarded.
Alternatively, because the market is so cyclic, put the cash away for days when commodities aren't priced so well. That's when there'll be a fire sale on many asset rich properties, and that's when to buy them.
Indeed, a bet plan would be to wait for the next bear market and line the company with asset rich properties from the fire sale.
Last Update: 2:40 AM ET Feb 7, 2007