Are Things About to Get Ugly for BHP Billiton and Vale?

Many mining stocks rallied significantly higher in the recent weeks. However, the rally was driven by hype and not improving fundamentals, which is why most of these stocks giving back the strong gains. BHP Billiton (BHP) is one such stock as it rallied from 52-week lows of roughly $18.5 to over $32 in the recent past, only to give up some portion of those gains. BHP Billiton is still considerably higher from its 52-week lows, and the stock should continue seeing selling pressure at these levels, thereby making it a sell.

Brazilian government claims $44 billion for Samarco disaster

In the most recent quarterly results, BHP Billiton shared that it is facing a lot of pressure due to economic uncertainty, geopolitical instability, and extreme volatility.  Moreover, BHP declined its 2016’s production guidance by 3% to almost 229 mt. The company is not able to make enough profits because of weak economic conditions in China, as China is the largest consumer of iron ore around the globe.

Although China is going through weak economic conditions, iron ore producers carry on surging production, with some of the miners reaching new record levels, thereby hurting iron ore prices.
Although iron ore prices have seen a trivial jump recently, it cannot be certainly said that it can rebalance the supply and demand cycle.

Samarco is a joint venture between Vale (VALE) and BHP Billiton, and everyone knows about Samarco disaster which took place in 2015. The Samarco disaster led to the death of 19 people, and approximately 1,000 km of the Rio Doce was polluted. Moreover, the water used for agriculture purpose was contaminated, and around 250,000 people were left without running water for some weeks.

This disaster has turned into an awful nightmare for Vale and BHP Billiton, as both the companies had formerly decided to pay around $5.6 billion to Brazilian government over the upcoming 15 years to offset the losses and repair damages.

Both the companies thought that this will end the claim process, but recently Brazilian government publicized that it needs $44 billion from both the companies together. The figure proposed by the Brazilian government converts into $155 billion reais and this value is approximately twice of Vale’s market value. If this happens, it would lead Vale to bankruptcy, and have a massive influence on BHP’s financial condition.

Apart from the Samarco disaster case, the stockholders are also worried about the company’s capability to meet interest and principal repayments. At present, the entire long-term debt of BHP Billiton is $32.48 billion. Although the company claims a differentiated portfolio, BHP’s performance still relies on commodity price fluctuations, which are habitually erratic.

Given the headwinds that BHP Billiton faces, it would be wise to sell the stock while it still holds onto some of the gains of the recent rally.
Published on Jun 1, 2016
By Vinay Singh

Copyrighted 2016. Content published with author's permission.

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