This was published 4 months ago
Opinion
The big money shift: How BHP is getting ready for the future
Stephen Bartholomeusz
Senior business columnistBeneath headline numbers that were disfigured by huge non-cash impairments and provisioning, BHP produced a respectably solid underlying result. Dig even deeper, and it is apparent that significant shifts are occurring in how the vast volumes of cash it generates are being deployed.
The bottom line, after $US5.7 billion ($8.7 billion) of impairments and charges related to the writedown of its nickel assets and new provisions for damages from the Samarco tailings dam tragedy, was a “paltry” $US927 million statutory profit.
BHP is upping its investment in what it describes as “future-facing commodities”.
If those extraordinary items are set aside, however, the underlying profit of $US6.6 billion for the December half was in line with that generated in the same half last year, and underlying earnings before interest, tax, depreciation and amortisation were 5 per cent higher at $US13.9 billion.
The group’s interim dividend of US72¢ was, as expected, lower than the corresponding half’s US90¢, albeit larger than analysts had expected, with the payout ratio dropping from 69 per cent to 56 per cent. A 57 per cent increase in capital and exploration expenditures probably explains the more conservative dividend policy.
Those capital expenditures reflect the changing composition of BHP’s priorities and future growth drivers.
In recent years, most of BHP’s spending has been focused on maintaining and developing its existing operations, with a tinge of investment in decarbonisation.
In the December half, however, there was a substantial increase in what BHP describes as “future-facing commodities”.
Those are primarily its Jansen potash project in Canada, its copper operations in Chile and South Australia, and, over the next few years, a potential expansion of its Western Australian iron ore operations.
The greenlighting of the $US4.9 billion stage two of the Jansen project by Mike Henry and his board last year – even before the first stage has been completed – has taken their commitment to potash to close to $US15 billion, a massive bet on the need for increased agricultural productivity driven by the global trends of increasing population, more urbanisation, more nutritional diets and the diminishing availability of arable land.
Growth in demand for copper is expected to be underwritten by decarbonisation, the continuing shift towards renewable energy technologies and the growth in the global electric vehicle fleet.
Automation and using artificial intelligence to drive more efficient production are themes within the big end of the resources sector.Credit: Krystle Wright
The investment in potash and copper and, over the medium term, an increase in iron ore production from around 260 million tonnes a year to, initially, 305 million tonnes and then, potentially, 330 million at some point in the next decade are the biggest influences over a planned increase in BHP’s capital expenditures from about $US7.1 billion last financial year to around $US10 billion this year and next and $US11 billion over the medium term.
There’s also, however, a shift from what BHP described as “organic development” expenditures to “improvement capital,” or spending on projects that improve the productivity of its existing asset base.
There is an emphasis on technology in that spending, driven by a significant and continuing rise in the labour costs that constitute about 44 per cent of its operating costs – even before the effect of the federal government’s controversial “same job, same pay” legislation kicks in. BHP has claimed the policy could cost it well over $US1 billion a year.
It is apparent there are significant shifts occurring in how the vast volumes of cash it is generating are being deployed.
The obvious response to a big increase in the cost of labour is to replace people with capital. Automation and using artificial intelligence to drive more efficient production are themes within the big end of the resources sector.
Within the core of its profitability, its iron ore business, which is the lowest-cost producer within the global industry, BHP is, like Rio Tinto, using automation and AI-driven scheduling of its complex logistics chain to improve productivity.
Being at the low end of industry cost curves will be increasingly important in future now that China’s growth rate has peaked and its steel production has plateaued.
The structural problems confronting China’s economy – the property sector’s implosion, over-investment in infrastructure, excess factory capacity and a shrinking population – mean miners can’t rely on it returning to the high growth rates of past decades to underpin their own growth.
Indeed, the reluctance of China’s leadership under Xi Jinping to resort to the traditional stimulatory measures, focused on property and infrastructure, that China has used to respond to economic weakness in the past means demand for steelmaking commodities (which has held up better than expected to date) may weaken considerably in future.
BHP chief executive Mike Henry is steering the company towards a greener future.Credit: Eamon Gallagher
The steady decline in China’s expected growth rate to, at best, around or just below 5 per cent this year and beyond, recessions in Japan and the UK, near-recession in Europe and slowing growth in the US don’t augur well for the short-term outlook for commodities, although India is a bright spot within the global economy,
The outlook for a future for commodities demand within which China’s growth rate plays a lesser role underscores why BHP’s pivot towards more copper production and potash, a continued emphasis on productivity and the deployment of advanced technologies not only make strategic sense but are the keys to a future less reliant on iron ore and metallurgical coal for its future growth and profitability.
Shifting the emphasis of future investment and the allocation of capital towards new commodities and technologies and away from those that have powered BHP’s earnings for decades does, however, entail a significant degree of risk given the sums involved.
Of the two commodities on which BHP is pinning its hopes and its balance sheet, copper looks like the safest bet, given BHP’s existing resource base and experience, the paucity of new low-cost resources and the impact of decarbonisation and the technologies associated with it.
Potash represents a riskier bet without binary outcomes. When they start producing towards the latter part of this decade, Jansen’s first two stages will have output equivalent to about 10 per cent of the global market. If BHP proceeded with stages three and four, it would at least double that output.
The timelines – BHP started looking at the project more than 15 years ago – and the scale of the capital exposed to the project’s success underpins the magnitude of the risks the big miners take when they green-light a major new project with only a sketchy understanding of what the market conditions might be like when first production eventually flows.
That is, of course, the nature of the business the big miners are in.
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