There is a slide in Andrew Mackenzie’s presentation to investors in Miami overnight that very clearly illustrates why the BHP Billiton chief executive believes the case for simplifying the resource giant’s portfolio is compelling.
The slide contains a comparison between BHP’s overall earnings before interest and tax margin and the margin it generates from its iron ore, copper, coal and petroleum assets.
The margin the group generates from its "basins" – the four pillars as Mackenzie has described them – is about 10 percentage points higher than its overall margin, which says that the gap between the margins generated by its best assets outstrip those of its lesser assets by a lot more than 10 percentage points.
That same slide also highlights the group’s increasing focus on expanding production from those core assets by showing production growth from its ‘’basins’’ growing by about 10 percentage points more than its overall production growth between the 2013 and 2015 financial years.
This afternoon, BHP confirmed it is reviewing options for its Western Australian Nickel West business, including a sale of all or part of the business.
The ‘’simplification’’ that Mackenzie finds compelling is ultimately about shedding the group’s aluminium, nickel, manganese, base metal and South African thermal coal assets, which have been estimated to be worth something around or above $US15 billion.
Those could be either sold to other players, like Mick Davis’ X2 Resources, Glencore Xstrata, Chinese buyers or private equity; or else, as has been speculated, packaged together and demerged to BHP Billiton shareholders.
Mackenzie wasn’t drawn on his preference for dealing with the lower-margin assets other than to say that the group continues to study the next phase of simplification (it has already divested $US6.5 billion of assets) and that those studies included ‘’structural’’ options.
In the meantime, by focusing its growth on the basin assets BHP has lifted the average rate of return for its new growth capital expenditures above 20 per cent.
As it has previously disclosed, however, BHP is pulling back its capital expenditures quite savagely.
This year capital and exploration spending will fall about 25 per cent to just over $US15 billion and will continue to decline, to below $US10 billion, in the 2015 financial year. With maintenance capital of only about $US2.5 billion a year that will create significant scope for either new investment or a big lift in returns to shareholders.
As Mackenzie said, anything beyond the maintenance capital is discretionary and any investment has to compete with the other prospective options, including capital management. Mackenzie has previously indicated that once BHP’s net debt falls below $US25 billion – a target it will probably hit sometime this year – it will actively consider returning capital to shareholders.
The prospective shrinkage in spending and in the portfolio, the focus on directing any new investment to projects with 20 per cent-plus returns on capital and the intense competition for the rationed capital, will, of course, continue to improve BHP’s average margins and returns even before its focus on improving productivity through cost-cutting and volume increases is overlaid.
Mackenzie reiterated that BHP has already embedded $US4.9 billion of productivity gains in the business, which he said would rise to $US5.5 billion this year. He described that as a ‘’solid start’’ but said there would be more to come.
The rapid reduction in new investment, the devotion of any new investment to the basin assets and the continuing improvement in the productivity of BHP’s operations are locked into BHP’s medium term future. They should generate significant momentum to BHP’s underlying performance even if commodity prices remain weak or, indeed, weaken further.
The big one-off and instant structural change in the nature of the portfolio and its returns would, however, come from the large-scale shedding of the lower-returning assets.
Mackenzie and his board have established the new strategy and embedded it in the group’s capital allocation and operational processes. With the relatively recent emergence of prospective buyers, there is little doubt that Mackenzie will be very focused on making that structural change happen as quickly as possible.