My friends, I bring you good news today. Big Australian mining companies finally, finally, understand what investors want.
It’s taken a decade and two changes of CEOs, but both BHP Billiton and Rio Tinto have confirmed in their results that they are now on a clear pathway to less capital being ploughed back into the ground and a greater share of sustainable profits finding their way into shareholders’ pockets. This is a VERY significant moment for both stocks.
Both companies, under new leadership, had promised to be more “shareholder friendly”. That is clearly now occurring, and I believe all of us are underestimating what different animals, and total return investments, both BHP and RIO will be under this new regime.
A new era
Andrew Mackenzie (BHP) and Sam Walsh (RIO) are going to run their businesses as hard as possible. No more wastage, no more grandiose capital projects, no more M&A. They are going to maximise their strategic advantage at the very bottom of the commodity cost curve and deliver low cost production growth into, what remain, high commodity prices.
They are going to drive every return metric up, with clear evidence of that happening in both results. That translates to mountains of free cash flow, that instead of being “evaporated” by empire building management, will find its way, via buybacks and dividends, into shareholders’ pockets.
I’ll say it again — this is a monumental change for the better for both BHP and RIO shareholders.
In September last year, when BHP shares were $33.86, I flew down to Melbourne to meet with Andrew Mackenzie one-on-one. I was one of the first stockbrokers to meet with Andrew and, at that meeting, I sensed a big change in approach from the BHP CEO that I reported in these notes. To quote from the notes of that meeting…
“It was pleasing to be asked by BHP to come and meet Andrew Mackenzie. I hadn’t met Andrew before, but after our meeting in BHP’s new head office I have greater clarity on the style of leader he will be at BHP.
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 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.
This cost out story is coming at a time of increased group production. While all of us, myself included, get besotted with daily moves in spot commodity prices, it’s easily missed that BHP, through new production coming on line and de-bottlenecking existing production, has guided to 8% group production growth in FY14 and 8% again in FY15, on a copper unit equivalent basis. Considering the scale of BHP’s existing production base, that is solid (16%) production growth on any measure. It’s also worth noting this is bottom of the commodity cost curve production growth, due to BHP’s tier 1 asset base, so highly profitable in the current commodity price environment.”
A promise delivered
Fast forward to this week and Andrew absolutely delivered on my forecast of BHP being “run hard, very hard”. The focus on “productivity, margins and free cash generation” are clearly demonstrated in the interim result which is summarised below.
Source: BHP Billiton
These numbers all beat the consensus analyst view and led to consensus earnings upgrades for BHP for FY14 and FY15. The fact the interim result, but particularly the free cash generation, beat consensus analyst forecasts so clearly, suggests to me that most BHP analysts don’t yet comprehend what a different beast BHP will be under Andrew.
It is somewhat counter-intuitive, but the best total shareholder returns from both BHP and RIO could come AFTER the commodity boom, as they exploit their unbeatable resource endowments instead of reinvestment.
We should also look at the RIO full year result. Every metric I look at in the RIO result was headed in the right direction in terms of what is required for investors to add sustainable P/E to the stock.
I realise the fact that RIO is currently a one trick ‘iron ore’ pony can cloud sentiment towards the company, on an iron view alone, but, if this was an industrial company, would the market not re-rate the stock if it produced the following?
RIO’s Results
Source: RIO
Similarly, all through the RIO results presentation pack are the words “greater returns for shareholders”.
Source: RIO
Source: RIO
The right stuff
I think Sam Walsh and Andrew Mackenzie are significantly different CEOs to their predecessors. I think you can see this already in the first FY RIO result under Sam. I think you can also see evidence of how hard Andrew runs BHP in the interim, in terms of cost out, margins and free cash flow.
The very, very clear point from the RIO and BHP results, is that P/E is going to continue to be reallocated from those who provide services to big mining companies back to the big miners. Our view has been unchanged on that for the last 12 months. Mining services are nothing more than stockbrokers in a bear market. No pricing or volume power, but even worse, most have plenty of debt. My conviction on that switch gets stronger each day. Zero weight mining services (or even short for hedge funds), and long big miners remains the way to be positioned.
I also think the corporate behaviour of RIO/BHP and even Fortescue (FMG) will set the stage for copycat behaviour further down the mining market cap food chain. That is why I remain very bullish on the right mid-cap producers.
Now all we need is for BHP to give us back some of the mountain of franking credits sitting on their balance sheet that should be in shareholders’ hands. That will happen at the full-year result in August, via an off-market buyback, and would be a genuinely positive surprise.
My strategy remains overweight big, mid and small miners (producers), with the world getting better and the big boys finally understanding what they need to deliver to shareholders.
As you know, the only way the ASX200 can get to 6,000, is if BHP takes over leadership of the market. I think that happened this week and we have cleared another sentiment hurdle on the way to 6,000.
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