BHP rattled, not rolled

At face value the BHP Billiton, with its halving of operating earnings, might appear to have been ravaged by the fallout from global financial crisis. It has, however, to be seen in context. While its resource industry peers, and others, were imploding as commodity prices and demand went from peak to trough almost overnight, BHP was generating record cash flows, massively investing in its businesses and declaring increased dividends.

The resilience of the BHP model of widely diversified resources and a focus on core cash flows couldn't have been better stress-tested.

The $US18.9 billion of net operating cash flow – up from $US17.8 billion in the boom 2008 year – and a balance sheet stuffed full of nearly $US11 billion of cash and with gearing of only 12 per cent is a testimony to the model. If further evidence were required, the underlying operating margin of 40 per cent (on an earnings before interest and tax basis) and return on capital of 24.6 per cent provided it.

In the extremely volatility of the circumstances that confronted the sector over the year the underlying strength of BHP's position is remarkable.

The strength and quality of the cash flows enabled the group to fund $US10.7 billion of capital and exploration expenditures and an annual dividend payout that has risen 17 per cent.  Its position has also allowed it to commit to at least another $US9.5 billion of investment in the portfolio – the bulk of it in growth projects – this financial year despite some reservations about the outlook.

BHP's ability to continue to invest heavily in its project pipeline through commodity cycles, and most particularly through the tsunamis that tore through the resource sector over the past year, has been near-unique at the big end of the resource sector.

Most of its rivals have been forced to shut down spending to conserve cash; most have been forced to raise equity at depressed prices to create some balance sheet stability. Arch-rival Rio Tinto was ultimately forced into a massive deeply-discounted rights issue and a joint venturing of its Pilbara iron ore operations with BHP that, if it gets the required regulatory clearances, will gain it a $US5.8 billion cheque from its new partner.

Marius Kloppers made it clear that BHP is committed not only to organic growth but also to continuing to scour the market for acquisitions that meet its criteria of being large-scale and low-cost.

The underlying result was a little better than the market had anticipated. Most of the $US6 billion of exceptional losses had been disclosed previously and to a degree reflect a necessary purging of projects that didn't hold up under the pressure of the crisis. The crashing of commodity prices and lower volumes accounted for about $US6.4 billion of the reduction in operating earnings, with the price impacts particularly severe in the second half but those were also already factored into expectations.

Despite some strengthening in commodity prices in recent months the group remains very cautious, unable to differentiate at this point between re-stocking and genuine underlying demand. It appears to believe that when the global economy settles and the re-stocking has been completed the outlook is one of subdued growth.

That doesn't necessarily mean that its own outlook is as sombre. The economic crisis and the collapse in commodity prices has put a big dent in the massive capital expenditures that were being made to expand the global supply of commodities to take advantage of demand and prices that had been soaring.

With that investment cut off and a lot of marginal production rendered uneconomic, BHP, with its ability to maintain investment and its focus on large and low-cost operations, should benefit more from any growth that does occur and would be very well positioned if there were a sharper recovery than anticipated.