A boom in BHP's pipeline

There will be millions of words written and spoken about the BHP results. But in essence, it's a tale of two graphs. Once you understand the message of those graphs you are a long way to understanding the strategy of our largest company.

BHP is engaged in the biggest capital investment and development program ever undertaken by an Australian company, but our first graph on sources and allocation of cash plus gearing shows how conservative the company has been.

To follow the graph you will need to enlarge it.

You will see that despite the sharp fluctuations in commodity prices in each year, the cash flow has been very close to the amount spent on capital works and dividend. In 2010-11, when cash flow was above dividend and capex, BHP effectively had a capital return. But in the latest December half, the major American shale oil acquisition boosted outlays well above cash flow, which lifted gearing to 25 per cent. This is not a high level and well below the levels of BHP gearing in the past decade.

Our next graph shows that the company has committed to $US27 billion worth of projects and so far it has spent 37 per cent of the money, or $US10 billion, so there is $US17 billion to go.

Cash flow in the half year was $US12.3 billion so – ignoring dividends for the moment – if cash flow is maintained at the December half-year rate, it will have covered the committed capital expenditure by September. While this is an oversimplification, it underlines the power of BHP in the current boom.

The second graph shows how important iron ore is in the current round of development. Remember that there is a string of further BHP projects that are undergoing feasibility studies and are likely to be committed in the current calendar year. One of the biggest of those is Olympic Dam.

BHP's policy is to organise its major projects to limit exposure. In theory, the most economic way to organise a project is to undertake the whole project at once but that considerably increases the risk. BHP is a China bull and believes the big performers in the next few years will be iron ore and copper, with oil depending on geopolitical factors. BHP believes that many of the rival new iron ore and copper projects will produce higher cost material than BHP, giving the company the opportunity to maintain or increase its margins.

The sharemarket does not share BHP's optimism. The December half saw the company earn around $A1.75 a share, or an annual rate of $A3.50, which has BHP on a price earnings ratio of about 10.5. BHP has an enormous string of projects in the pipeline which are not exciting the market.