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An Analysis of BHP Billiton’s Olympic Dam Upgrade: What does it mean for investors?

The Daily Reckoning Australia’s Al Robinson breaks down BHP Billiton’s big Olympic Dam announcement today. What does it mean for future earnings and the present stock price? Listen in on the full report at the link below (runs about five minutes) or read the full transcript.

BHP Billiton Podcast

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Podcast Transcript: This is Al Robinson from the Daily Reckoning in Australia.

Resource investors world-wide eagerly awaited today’s release of annual results from Melbourne-based BHP Billiton (ASX: BHP), the world’s second largest diversified mining company.

BHP Billiton’s U.S. listing (NYSE: BHP) climbed by 18% in the last two weeks on a rumour that the company would upgrade its gold resources at its Olympic Dam mine in South Australia enough to make it the largest gold mine in the world.

What exactly did the company reveal in its annual report today? Specifically, how large was the upgrade in the resource base, will those resources become reserves, and what is the short-term and long-term impact on earnings and, more importantly, the stock price.

BHP upgraded resources at Olympic Dam to 7.7 billion metric tonnes from 4.4 billion, a 75% increase. The resources in question are uranium, gold and copper.

The more important number may be 6.7%. That’s the increase in the amount of material that can be economically mined at the site. On face value this may seem like a modest increase when compared to the 75% boost in resources.

But mining companies are required to scrutinise ore samples more closely when determining economic feasibility, as opposed to the mere existence of material.

As BHP conducts further drilling at the site, its reserves will gradually increase as Olympic Dam approaches full production in 2013.

It’s too early to quantify precisely how much of the new resource base will translate into actual reserves. That said, analysts here expect reserves to increase by as much as 3 times.

What is the short-term impact of the official announcement?

The upgrade isn’t likely to significantly affect earnings. Business earnings are a function of revenues and costs, but at this stage nobody even knows for sure if an expansion at the site is feasible.

BHP is in the process of conducting testing to determine whether it’s worth investing more cash in the mine to increase production.

If it does so, the positive effect on earnings will accrue as the company increases infrastructure and capacity. The outlay involved would be AU$6 billion; this would have a negative effect on profit growth in the short term. However, in the long term, higher production will mean greater sales.

BHP’s planned expansion at Olympic Dam could increase copper production two-fold, and uranium production three-fold. Copper uranium and gold are at historically high price levels. But the real benefit from the mine is to the bottom line of BHP’s base metals unit.

The stock price should continue to follow the long-term increase in earnings. But investors will also attempt to anticipate the future. As BHP makes more resource and reserve announcements, its share price will adjust to reflect greater probability from higher future production.

Ignoring short-term volatility, we believe the company’s long-term market value will increase as the mine is expanded and as the pipeline of new projects enters production.

While the upgraded resource base at Olympic Dam may not begin benefiting BHP’s bottom line for a few years, the company has an impressive portfolio of producing assets and new assets in the pipeline that investors may not be aware of.

The company has 33 projects either in the execution or feasibility phase. Those projects represent US$20.9 billion in capital investment. The company reports another list of medium-term projects requiring $50 billion in investment.

BHP’s long-term price forecasts for commodities are clearly bullish. What may surprise some investors is the diversity of BHP’s asset portfolio and the composition of its earnings.

The base metals group—which includes copper, lead, and zinc—generated $6.9 billion pre-tax earnings in the last year. Stainless steel—driven by BHP’s Ravensthorpe and Yablu nickel operations in Western Australia—contributed $3.6 billion.

Oil from the Bass Strait in the South and BHP’s share of the LNG project in North West shelf contributed $3 billion in pre-tax earnings for the company, and makes BHP a beneficiary of rising oil prices.

The Iron Ore group in West Australia—which represents BHP’s direct connection to demand for steel-making materials in China—generated $2.7 billion in pre-tax earnings. The other operating groups, Aluminum, Metallurgical Coal, Thermal Coal, Maganese , and Diamonds and Specialty products produced a combined $3.9 billion in pre-tax earnings.

While Olympic Dam gives BHP potential gold assets going forward, its chief assets are its iron ore deposits in West Australia, the Cannington silver, lead, and zinc mine in Queensland, and one of the world’s largest copper mines in the world with the Escondida mine in Chile, where BHP is a 57% stakeholder.

BHP’s quality assets and long-list of development projects are indicative of an even larger boom taking place in the Australian Resources sector.

The Australian Bureau of Agricultural and Resource Economics estimates $43 billion in capital spending for new resource projects in the next twenty four months.

For continuing coverage of that story, stay tuned to http://www.dailyreckoning.com.au.

Al Robinson
The Daily Reckoning Australia

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