BHP shareholders, enjoy the ride

BHP has been a traditional backbone stock for most Australian long-term investment portfolios. And that is why around the land there is great rejoicing now that BHP has risen above $42 – a new high.

BHP shareholders have had a tough ride in the last decade or so and fully deserve the current wonderful time on the back of the high iron ore prices supplemented by copper.

I don’t know when the iron ore boom ends but I do know that the anti-BHP rage in China led by President Xi Jinping is very strong.

At the moment there is strong Chinese demand for iron ore and Brazil is not producing at the levels that China had hoped. But in the next five years, China will do absolutely everything it can to lessen dependence on Australian iron ore because they believe we are price gouging them.

There is an extra level of frustration because China believes Australia needs to be punished as an example to the region for stating its views and so China is inflicting a series of well publicised blows to Australian exports.

However, at least to date, those blows have been swamped by the extra revenue we are receiving from the higher iron ore prices. 

So, my message to BHP shareholders is – enjoy the ride, the profit that BHP will generate in the next year or so will be nothing short of fabulous and the market clearly senses this.

But irrespective of what might happen in the relationship between Australia and China, the Middle Kingdom is going to leave no stone unturned to reduce the price of iron ore.

Their options will include boosting Brazil, African iron ore from Simandou, much greater use of scrap and switching the current economic boost away from infrastructure to consumer demand. 

They will try to pull all four levers and we will need to monitor their actions because BHP will be in the front line of the counter attack.

Meanwhile, the actions of China have enraged Australians and increasingly we are looking at where products are made and choosing products that do not have the word China on them. But we are too small for that to have impact on China, it must be a regional affair. 

It’s true that Australia’s largest winemaker, Treasury Estates, is being hit hard by the China tariff along with many other winemakers. A number of reports had Treasury marketing some its wine into the Taiwan market under the label “freedom wine". 

Somewhat sadly, I report that Treasury says very firmly that they are not doing that and will investigate whether wine brand counterfeiters in Taiwan are the culprits and stop it. I fully accept their statement.

Those companies that are dependent on exports to China are going to need to be very innovative in seeking diversification or alternatively adjust their operations to a lower turnover. 

Irrespective of China's involvement, we are seeing a large number of Australian enterprises now relooking at how they run their businesses in the light of the COVID-19 experience.

No one is more public and more aggressive than Qantas on this front.

CEO Alan Joyce has clearly looked at his entire operation and decided the COVID-19 disaster is a once in a lifetime opportunity to rid Qantas of all the old work practices and high cost mechanisms that had remained with the company.

He was, of course, helped by the collapse of Virgin and the fact that the new Virgin owners have moved very quickly to undertake a similar procedure.

To some extent, Joyce is riding on their coat tails but the Qantas that will emerge will be a far more efficient and profitable company than existed pre COVID-19.

The benefits of what Joyce is now doing will take some years to hit the bottom line because airlines are not going to return to their old turnover levels in the short term.

Around the country, without publicity, many other enterprises are doing exactly the same thing.

In the coming interim reporting season, look carefully at all the companies where you have shares to see if the board and managers have taken the opportunity of the COVID pandemic to improve the efficiency of their operations. 

Those that sit on their hands will be very vulnerable to rivals or newcomers who have a lower cost base and better marketing. 

When Westpac sold out of its Pacific Island banking operation the headlines were relatively small. But those with a sense of history remember that after the merger with the CBA bank in 1982, the new organisation was called the Western Pacific Banking Corporation – or WESTPAC.

The board of the day envisaged the newly merged bank to be an important regional player. It didn’t happen.

Around the same time, ANZ purchased Grindlays Bank and it too saw itself as a regional bank and of course, NAB went to the UK.

At the time we believed we had banking talents that could be exported to the region and other countries. NAB certainly failed in the UK as did AMP. We never really tested our abilities in the region.

The lure of the home loan bonanza for local Australian banks meant the institutions did not want our managers to develop regional operations where the margins were lower and the cost of buying in was high.

So, while we have a presence in the area it is nothing like what was originally envisaged. 

That means for investors who want exposure to the region then, apart from buying into exporters, including our mineral companies, you have to buy regional stocks.

Housing loans are still generating excellent profits for banks but increasingly it is a commoditised market and banks are going to have to gain their growth by becoming lower and lower cost operators or look for different markets. 

At this stage, the small business cash flow lending looks the best prospect, but it will require skills banks don’t currently have. 

I still feel that an opportunity was lost at both Westpac and ANZ but, as the Westpac sale shows, that is history.

Fascinatingly the regional expansion of Australian enterprises is coming out of technology companies such as Airwallex and Atlassian.

Airwallex has established a global currency banking service covering 130 countries and it is moving hard into the region.

And of course, there will be other disruptors to the existing banks.

So maybe the institutions were right and that our banks didn’t have the technology skills to ride a different market.

The money that would have been spent on regional expansion went to fully franked dividends to shareholders.