How do the spending plans of Australia's diversified mining majors stack up? BHP's (BLT) balance sheet is ungeared and Rio Tinto's (RIO) is inching closer. When looking solely on the basis of gearing BHP appeared positively miserly over the last decade--with average gearing around 33%. It would have been a starkly different picture if bids for RIO in 2008 and/or PotashCorp in 2010 had proven successful. Perhaps a picture more akin to RIO's none-too-brief flirtation with 200% gearing levels following the $38 billion Alcan acquisition in 2007. A $15 billion restoring rights issue in 2009 and non-core sell-downs have RIO on the front foot again. Not to mention extraordinarily favourable iron ore prices and top-heavy Pilbara iron ore exposure! At 66%, RIO's average gearing over the last decade is around double BHP's.
On average BHP and RIO expended the equivalent of 14%-15% of revenue on new capital investment, excluding acquisitions. The difference is BHP spent comparatively less at the beginning of the decade and more toward the end. RIO's expenditure levels halved following the Alcan acquisition and only after two years are they now back to 15% of revenue. The $15 billion entitlement issue, belt tightening, belated non-core asset sales, and strong commodity prices brought RIO back from over-indebtedness far sooner than might otherwise have been expected.
BHP delivered the superior returns on invested capital (ROIC)--25% on average over the last decade versus RIO's 18%. Only in 2006 did RIO's returns match BHP's, courtesy of high iron ore and copper prices. Alcan and poor aluminium prices erased that advantage for RIO in subsequent years.
Is RIO a diversified miner? It's getting harder to claim that with 60% of EBIT now derived from iron ore alone. Copper remains a reasonable slice at around one quarter, but coal, aluminium and industrial minerals are becoming tantamount to also-ran commodities. As for diamonds, forget about it! BHP maintains a far more balanced portfolio although even here there is a decline in symmetry toward steelmaking materials or CSMs--metallurgical coal, manganese, and iron ore. Of course this is not necessarily a bad thing--you've got to make profits where there are profits to be made. But still we can't help but harbour some concern around increased exposure to one segment. It's working in the miners' favour at present and they are running with it.
How much of the increasing earnings asymmetry is a function of commodity prices as opposed to directed investment? Noteworthy for RIO is the decline in aluminium’s contribution despite the massive Alcan acquisition. Aluminium for BHP is also presently a sliver of its former self.
For BHP and RIO the growth in importance of CSMs to earnings is a function of investment skew and prices. Each has grown the proportion of investment dollars directed to CSMs considerably. Over the decade, BHP doubled CSM expenditure to 40% from 20% of the total. RIO didn't grow it as sharply but it was generally already higher, on average 35% of total capital expenditure versus 30% for BHP. However, the growth in earnings contribution from CSM was even sharper, tripling for RIO and nearly doubling for BHP. High iron ore and coking coal prices were a key driver of this growth in earnings. Aluminium expenditure as a proportion of total spend was surprisingly high for RIO and this ignores the Alcan purchase cost. You wouldn't know it though from the earnings profile--RIO is well-primed for an aluminium turnaround. Also interesting is the cranking-up of oil and gas expenditure by BHP.
BHP spent $11 billion in fiscal 2010 and is planning $15 billion in fiscal 2011. It has 20 projects in the growth pipeline with some of the bigger-ticket items on oil and gas. These include Macedon $1.1 billion, Bass Strait $1.1 billion, and NWSJV over $1.0 billion. The company recently approved $570 million for Rapid Growth Project RGP5 expanding on earlier pre-commitments of $1.7 billion. RGP5 increases Pilbara iron ore capacity by 50 million tonnes to 205 million tonnes by 2011. Further, it wouldn't surprise us if BHP is furiously running the ruler over Woodside Petroleum, now that Shell has flagged its exit intentions. BHP missed out on RIO and PotashCorp and its balance sheet is chronically under-geared--even with capex plans and the re-instituted $4.2 billion buyback of Billiton shares.
BHP remains our preferred diversified major. It had the more consistent and superior returns over the last decade, reliably invested throughout the commodity cycle and retains the more diversified and balanced asset portfolio. Capital expenditure plans suggest it will stick to this approach. Our valuation climbs marginally to $87 per share after a rise in near-term iron ore price forecasts. Fiscal 2011 iron ore increases 13% to $130 per tonne and fiscal 2012 10% to $113 per tonne.
