Potholed by disappointments both expected and surprising, BHP Billiton’s generally encouraging interim results affirm that global mining finds itself in the warming glow of an almost secret resources boom.
If we received the present state of bulk minerals, base metals and energy markets through a long, historical lens, rather than one coloured by our most recent 21st century extravaganza, then this boom-time reality would be rather more obvious to all.
BHP’s first half numbers don’t quite match it yet with the best of its competitors, Rio Tinto.
But, despite a confidence-denting miss on earnings consensus and a slightly messy operational performance through the half, chief executive Andrew Mackenzie has unquestionably righted the financial ship and is on track to follow Rio down the virtuous path to capital management.
Mind you, the fact that BHP’s controllable costs blew out by $US800 million ($1 billion) over the half sits a bit of a worry, not least because it more than overwhelmed hard won productivity gains, which generated an additional $US400 million in cash flow gains.
The more positive side of the coin was pricing. Through the December half stronger prices generated an additional $US2.2 billion in EBITDA, which topped $US11.2 billion.
BHP threw off $US4.9 billion in free cash for the half but noted that if prevailing spot pricing persists that full year cash flow would match the $US12 billion produced in FY17.
Net debt has been pruned by 23 per cent to $US15.4 billion over the past year but repayments over the first six months of the financial year were modest. Chief financial officer Peter Beaven made it plain that the promise of stronger cash flows through the second half would likely drive a similarly overweight reduction of debt. And, in affirming a floor on BHP’s debt target of $US10 billion, Beaven appeared to be telling us that the balance sheet would soon be in a state fit enough to allow the flow through of any free cash generated by the steadily progressing retreat from shale.
There are forecasts that BHP could extract up to $US10 billion from the end of its shale dreaming. It would seem reasonable to expect that return to flow directly to shareholders through the same sort of out-of-cycle buy back that Rio funded with the highly remunerative sale of its Hunter Valley coal business.
BHP has illuminated its intent by lifting the interim dividend 38 per cent to US55¢.
Now, if you need further evidence of a commodities cycle turned, just reflect briefly on the full-year numbers that Rio celebrated two weeks ago. Incremental volume growth added a modest $US100 million to its underlying profit through 2017 while $US400 million of cost management fully mitigated $US400 million of cost inflation. As a result, better prices for iron ore, aluminium, copper and coal flowed with brilliantly calibrated efficiency to the bottom line, adding $US4.1 billion to a full-year underlying profit that hit $US8.6 billion.
This interim season has seen a set of themes emerging consistent across the resources sector. Revenue and profit margins are generally up, complications and capital investment are generally down and balance sheets continue their long marches to that point where they will support substantial and sustained share buybacks.
Management focus remains squarely on sustaining a still-reducing productive estate, on maintaining supply-side status quo in markets that continue to evince growing demand and on driving operations to peak productivity while the gateways to future mining are opened, assessed and leveraged.
The resilience manufactured by what has been standard operating procedure over half a decade of post-boom hangover is now working to amplify the benefits of coincident growth in demand for minerals, metals and energy that has been fathered by renewed economic momentum in the three drivers of global prosperity, China, Europe and the United States.
At the same time, the demand story has been further underpinned by long-flagged potential of emerging resources markets like India that is suddenly being made real in seaborne markets.
The other cornerstone to this more traditional resources boom-time story is that the miners appear determined to maintain promised capital allocation and production disciplines in the face of what would appear to be incentive pricing.
Pretty much everyone in the sector has embraced the value-over-volume strategy that argumentative outlier Glencore’s Ivan Glasenberg recommended to his competitors nearly three years ago and that is now most effusively owned by the new guy on the block, Rio Tinto chief executive Jean-Sebastien Jacques.
Strong market conditions
For mine, the most certain litmus of this new sectoral discipline is that the supply or demand side disruptions pretty routinely result in material price spikes. Look at the way the copper price responded to last year’s industrial trouble at the BHP-Rio owned Escondida mine in Chile and what the copper market has done this year as it contemplates the risks of more widespread strike action in the home of global copper.
And look too at what happened recently to the regional liquid natural gas price when winter cuts in coal-fired power capacity saw China go looking for spot shipments in what was supposed to be an over-supplied LNG market.
BHP reported on Tuesday evening that short-term market conditions remain on the brighter side of resilient. That view is informed by some old and new realities.
Changes structural and seasonal to China’s raw materials consumption have served to reward the quality of inputs that the likes of BHP and Rio Tinto offer. The consolidation of China’s steel industry has trimmed national capacity but the steel make remains the same. This has created a virtuous circle of global benefit. The only way to produce the same volume from a smaller industry is to improve the quality of inputs. The result is higher prices for premium quality coking coal and iron ore.
The other benefit is that China has been sending less steel to the world. This and slow but steady increases in steel demand across the US and Europe has seen the steel industry outside of China have its best run since 2010.
At the same time, energy markets are seeing more traditional trading bands with oil benchmarks showing new resilience in the face of continuing supply-side evolution forced by the US shale revolution. Gas prices, pretty much across all markets are encouraging in North America and north Asia and are excessively robust in Australia.
Big mining has been consistently lampooned for the ambitions of the capital investment that was made in the wake of China’s arrival in global metals and the seaborne bulk minerals markets. But there is evidence enough to suggest that, as promised, the era of over-capacity would be fleeting and that a combination of underlying demand-side growth and the inevitable decline of legacy production would see a recovery of more balanced markets.
Sure, shale was a huge and costly misjudgment that ended careers. But not all of those China-fuelled ambitions were misplaced. BHP and Rio have, at various times, taken spankings from investors and competitors alike for swelling their individual iron ore arms.
BHP, for example, invested more than $US20 billion in iron ore through the China-boom years to more than triple its nameplate Pilbara system capacity to 290 million tonnes a year. Along the way, BHP allowed production costs to balloon in the name of capturing the tail winds of mind-boggling prices that saw iron ore cargoes changing hands at better than $US190 a tonne.
In 2006, China imported about 120 million tonnes of iron ore. In total.
Last year China tapped seaborne iron ore markets for 1 billion tonnes of iron ore. And 650 million tonnes of that arrived from Australian mines with the overwhelming majority of those shipments being dispatched by Rio, BHP and Fortescue. This investment is now reaping rewards for investors and the nation.
Through the December half BHP’s iron ore profit engine lifted revenues by about 3 per cent and underlying profit by nearer 6 per cent on the back of average pricing of $US57 a tonne. The raw numbers of that are revenues grew by just shy of $US300 million to $US7.22 billion. From that the business threw off free cash flow (EBITDA) of $US4.3 billion and an underlying profit of $US3.43 billion.