BHP Billiton – still on message

Chief Investment Officer and founder of Aitken Investment Management
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BHP Billiton remains Australia’s largest global market capitalisation company yet I continue to feel the cultural and business change under CEO Andrew Mackenzie is under-appreciated by most investors.

There are two reasons for this. The first is that Mackenzie is relatively low profile and goes about his business of running the business. That is a very good thing. The second is when it comes to mining stocks, the market is besotted by commodity prices rather than stock specific internal stories.

To my way of thinking, this is leading to the BHP cost out, productivity, production growth, simplification and capital discipline story sneaking up on investors who are purely focused on the daily spot price of iron ore.

No doubt the falling iron ore price and resilient Australian dollar are macro negatives for BHP (currently 48% of group revenue), yet with their high Fe grades, and place at the bottom of the iron ore cost curve (plus commodity diversity) they are the least affected by falling iron ore prices in Australian dollar terms.

But the iron ore price is a transparent “known known” and what I want to focus again on today is the less focused on story of what Mackenzie and his management team are doing at BHP.

Flashback

I first met one-on-one with Andrew Mackenzie last year. Below are a few points I made in these notes about that initial meeting (30 September 2013):

Mackenzie is of Scottish heritage and like all good Scotsman watches the pennies very closely. I believe you can look forward to a period of BHP being run hard, very hard, with a through the business focus on productivity, margins and free cash generation.

I wouldn’t be expecting any wastage on Mackenzie’s watch, in fact I expect the complete opposite.

It’s worth noting Mackenzie has even appointed a group “productivity officer” who reports directly to him. The business unit leaders have been given productivity benchmarks and I suspect it’s fair to say we all could be underestimating the cost out story at BHP. It’s worth noting BHP reduced controllable costs by $US2.7 billion in FY13, with Mackenzie only in control for two full months of FY13.

In summary, under Mackenzie I think BHP is going to be the free cash machine we all hoped it would be. I just don’t think you’re going to wake up one morning under Mackenzie’s leadership and be surprised by a $50 billion tilt at some other company. We might actually be surprised how “boring” BHP becomes, but boring is good when you are the bottom of the cost curve and increasing production, while simultaneously stripping out costs and reducing capex.

Not that it’s my role as a lowly stockbroker to give the CEO of BHP Billiton advice, but the only piece of market based advice I gave Andrew Mackenzie when I sat down with him was that whenever anyone from BHP speaks to investors, analysts or the press that they deliver a consistent and clear message.

(You can read the rest of Charlie’s report on BHP last year here).

The story today

Fast forward to today and Mackenzie remains “on message” and delivering what he said he would.

Earlier this week at a conference in Miami, BHP produced evidence of the business changes under Mackenzie.

Interestingly, Mackenzie’s opening remarks at Miami were “Today you will hear me repeat a number of things I’ve said before because maintaining your confidence is about being predictable and consistently delivering on our commitments”.

I think it’s worth running through a few of those “evidence” slides.


BHP is controlling the controllables. They can’t control Chinese GDP growth or commodity prices but they can control their place on the cost curve, production volumes, productivity, simplicity of their business, and capital allocations.

Simple things, like open pit digger fleet utilisation being up 10%, and truck fleet utilisation rates being 8% are driving BHP’s margins and free cash in the right direction.

Focus on the controllables

In the presentation, there is also a clear change to focus on what BHP can control, from macro outcomes they can’t control. I think that is a good development for BHP shareholders with the entire market underestimating the margin and free cash flow uplift from BHP sweating their assets harder. Note the comment “we will grow margins even in the absence of higher commodity prices”.

The other clear message from the presentation is that BHP is going to focus on its four pillars (iron ore, petroleum, coal and copper). It’s probably fair to assume the rest is on the chopping block. This is good news as it will increase BHP’s ROE and further increase group productivity and margins.

BHP, under Mackenzie, is on its way to be a simpler, more productive and capital efficient organisation. That is a good thing for shareholders.

While I am cautious on iron ore, iron ore pure plays and the broader ASX200 at the moment (absolute value hard to find), it’s worth noting that BHP has underperformed the ASX200 sharply over the last two years in particular. This is the largest underperformance I can ever remember of BHP to the benchmark index, of which it represents 9% itself.

I believe this gap will close over the years ahead, as investors come around to my views on the business improvement at BHP under Mackenzie. Investors will start to realise that the sharp improvements in productivity and production growth will offset falls in spot iron ore prices for this diversified group. They will also realise they will receive a greater percentage of rising free cash flow in the form of dividends and buybacks. All that will lead to medium-term P/E expansion.

On 13 times FY15 consensus earnings, and offering a gross yield close to 5%, BHP remains the core portfolio mining holding in Australia/world. And its growth is essential if the ASX200 is going to get anywhere near my long-term 6000 target.

The point of today’s note is that BHP Billiton under Andrew Mackenzie and his management team remains 100% “on message”, a message which is not yet broadly appreciated by investors.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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