BHP Billiton (BLT) reported a better-than-expected 31% increase in first-half 2014 earnings to $7.8 billion. However, excluding the $491 million gain on re-measurement of the deferred tax asset associated with the mineral resources rent tax, $7.3 billion is closer, though still ahead, of our pre-result forecast of $ 6.7 billion. The driver of outperformance was copper, with earnings before interest and tax doubling to $2.9 billion on higher pricing and lower unit costs, reflective of higher grades.
The petroleum division was another first-half 2014 outperformer, important given it's a low-cost, long-term growth driver that contributes to the company's narrow moat. Petroleum is a key back-up to the main narrow moat driver, low-cost Pilbara iron ore. It is pleasing to see iron ore's earnings before tax contribution fall from 56% to 52% of group total in first-half fiscal 2014, as copper and petroleum pick up more of the slack.
Despite hefty iron ore expansion programs, we expect iron ore to normalise to about 35% to 40% of earnings before interest and tax by 2016 as prices soften to our long-term $90 per tonne forecast, versus $125 currently, and as petroleum grows from 20% of earnings before tax now to about 30%, in line with U.S. shale volume expansion. This dynamic is in contrast to Rio Tinto (RIO) where iron ore represents more than 90% of second-half 2013 earnings before tax and is unlikely to fall much below 65%, even in the long term. That's fine while iron ore chugs along nicely, but there is danger in having all your eggs in one basket.
BHP Billiton has a healthy share of the world's largest and lowest-cost mines. These are readily expandable and BHP has been investing billions of dollars to that end. It has increased iron ore production by about 50% during the past three years. Most recently the firm approved expenditure, including Rapid Growth Project 6, that will increase installed Western Australian capacity 10% to 240 million tonnes per year by 2016.
Mining companies are largely producers of undifferentiated commodities. In the long run, they have been price-takers, not price-makers. But firms such as BHP have gained more say with growing concentration because of takeovers and mergers. We assign BHP a narrow moat rating (competitive advantage over peers). The breakdown of the traditional iron ore contract pricing system in favour of an index-based mechanism, reflective of industry fundamentals, is a boon to miners and evidence of the not-so-subtle shift in power.
