bhp know - world steel demand to grow in 2010, page-11

Keeping them on the other side of the fence is additional value to the worth of the resource IMO...

http://news.mining.com/2009/10/02/eight-things-you-need-to-know-about-the-new-bhp/

Eight things you need to know about the new BHP
By Robert Gottliebsen
October 2, 2009


PORTFOLIO POINT: BHP has a luxury of being able to set strategies for commodities whether prices rise or fall. But the annual report does include eight key issues.

One way or another BHP Billiton, Australia’s biggest listed company, is at the core of most Australian share portfolios and over the past decade it has been a big factor in the strong performance of Australian shares. In turn it has been a key part of the recovery in the past six months.

This week I had a good look at the strategies BHP is implementing. As you look deeper what emerges is a remarkable set of future plans.

The strategies are outlined clearly in the annual report, which many Eureka Report subscribers will receive in the post. I have isolated eight significant points from the report that investors should consider.

1 The first also includes a warning for the short term. On page 7 of the BHP Summary Review, chief executive Marius Kloppers says: “We may see a more predictable demand scenario for our products in the coming financial year. However, we do not expect a return to the same buoyant demand conditions that prevailed before the global financial crisis, or a return to record global growth rates in our forecasting horizon.”

Kloppers does not spell it out, but what he is implying is that there is a high likelihood that the excess liquidity in the financial system is fuelling rampant speculation in commodities, led by copper and oil.

At some point in the next 12 months the excess liquidity in the system will begin to dry up and it will be back to demand fundamentals. In those circumstances we could see a significant correction in commodity prices and, with it, Australian mining shares. Last night's sharp fall of 2% on Wall Street was the worst day on US markets for three months suggesting the markets are still open to sudden bursts of downward pressure.

BHP has been wrong before in its predictions, which is why Kloppers has chosen his words carefully. But all investors need to factor into their longer-term thinking the clear possibility that the boundless optimism that has embraced commodity and share markets in recent months may suffer a set back if overall demand in Europe and the US does not recover strongly.

2 Now we go to page 16 of the BHP Summary Review and look at the words of chief financial officer Alex Vanselow, who says: “Our financial strength has differentiated the group during this severe economic downturn and leaves us well positioned to make opportunistic acquisitions. The iron ore production joint venture we announced with Rio Tinto is an example of our ability to add world-class capacity.”

Now, given that BHP believes we are not going to return to the old growth rates and that the markets looks a bit over heated it would be foolish of the company to suddenly embark on a major takeover binge.

So what is Vanselow on about? I think he means is that if there is a correction then a large number of mining companies whose balance sheets have not been fully repaired they will be in all sorts of bother. Some will want to sell assets that BHP wants. If that happens BHP will be there to buy them.

3 What happens at BHP if there is no correction in the next year or two and we proceed ever onwards?

The answer lies in the chairman’s address on page 4 of the BHP Summary Review. Outgoing chairman Don Argus points out that BHP’s long-term strategy delivered record operating cash flow of $19 billion and the group’s gearing was only 12.1%. Clearly, the BHP balance sheet is simply too strong for the longer term. If commodity prices keep rising then cash flows will explode but in that event acquisitions would be too costly.

BHP is then in a wonderful position to buy back its own shares because the UK dual-listed vehicle is selling at a discount of 15–20% to the Australian company. This divergence is happening because although the BHP assets are the same, institutions don’t want equity expressed in sterling and prefer to buy the Australian company.

A cashed-up BHP is clearly in a wonderful position to buy back stock but would prefer to use its balance sheet to buy assets if they are available at the right price.

4 Early in 2010 Don Argus will retire as BHP chairman; he has done a wonderful job. He will be replaced by Jac Nasser. I am not an insider at BHP but given what I have seen of Nasser when he was rising to the top of the Ford Motor Company he will be asking myriad questions about costs and cost strategies. This is a good thing.

Nasser has direct experience in making takeover mistakes so he will be vetting any proposal that comes forward very carefully indeed.

5 About every decade BHP makes a major mistake. In the 1990s it was on a mission to grow; it bought Magma Copper in the US and lost many billions. About the same time it punted that it would be hard to sell fine iron ore in the future so it erected a massive HBI (hot briquetted iron) plant in WA to convert fines to a metallised product to rival scrap. The plant never worked properly and the iron ore market assumptions were totally wrong. The company vowed never to make the same mistake again, but did so in the Ravensthorpe nickel project.

This time round BHP management thought that the future of nickel production would require the use of much more lateritic ore. While that conclusion was right BHP’s response was a complex and expensive plant that would produce a metallised nickel product that again rivalled scrap. Once again it failed, and the $3 billion Ravensthorpe plant was closed recently.

The good news for BHP shareholders is that, history suggests it will be at least another 10–15 years before it makes a similar mistake.

6 BHP has been struggling with lower oil production but has embraced operational techniques that have improved output. It has also commissioned a series of new production wells. It would seem that the BHP’s costs per barrel are $US6, which makes it one of the world’s lowest-cost producers. That means even if there is a fall in oil prices BHP will continue to make large sums on oil, particularly as production is set to increase at 10% a year for the next couple of years.

7 One of the least talked about BHP products is metallurgical coal, which achieved an incredible four-fold increase in underlying earnings before interest and tax (EBIT) of $4.7 billion in 2008-09. Only iron ore produced a larger underlying EBIT ($6.2 billion).

Metallurgical coal, which is used in the production of steel, is a Cinderella for BHP and it has on two occasions seriously considered increasing production. But each time other projects have gained favour at metallurgical coal’s expense. It seems that once a steel maker uses Australian metallurgical coal in their furnace the efficiencies are so strong they are hooked, and have to keep buying more.

It is going to continue to be a winner for BHP in the coming years and because traders are not involved the big rise in price it is likely to hold.

8 It would seem that in November or December we will have a much better idea of any difficulties that arise from the BHP-Rio Tinto iron ore merger, but the executives of both companies appear to be making good progress. There is even a photo of Rio Tinto chief executive Tom Albanese on the BHP website.

The merger is vital for BHP as it rationalises future increases in production, and it will generate big cost falls. Almost certainly iron ore will, in future, be priced on the basis of some form of index arrangement. China is predicting lower prices but they are obviously biased. Either way, in the longer term BHP is well placed.

BHP is one of the few companies that is in a position to have the luxury of a strategy for lower commodity prices and a strategy that can be applied it they keep rising. Those punting the commodity market need to be aware of BHP’s apprehension but longer-term investors know that BHP will use any fall to increase long-term wealth. And if there is no fall BHP is in a wonderful position to rationalise its capital. That’s an enormous comfort for long-term investors. "