BHP's iron core won't rust

At face value BHP Billiton's first-half result might appear a little disappointing. In the resources boom era, the market has become accustomed to ever-soaring profits and dividends and regular capital management initiatives from the industry heavyweight – not profit declines, steady dividends and no buybacks.

Appearances can, however, be deceptive and in some respects the modest 5.5 per cent fall in earnings underscores the resilience of the vast portfolio of high-quality projects the group has developed.

On an underlying basis, earnings before interest, tax, depreciation and amortisation was actually up eight per cent, to $US18.7 billion, and operating cash flows were marginally higher than for the same half of 2010 at $US12.3 billion.

That's despite the falling away, from record levels, of the prices for most of the group's key commodities as the December half progressed. More particularly, the $US9.94 billion after-tax result was achieved despite a number of events outside BHP's control that adversely impacted a number of its key projects.

Marius Kloppers referred to the "latent capacity" across a number of his major businesses. Lower grades and industrial actions constrained production at the giant Escondida copper mine in Chile. The group's Queensland coal operations were still being affected by last year's floods, and the continuing industrial disputes. Its Gulf of Mexico oil business was impacted by the moratorium on drilling that was imposed after the Deepwater Horizon spill.

Escondida's production is expected to rebound next financial year, the impact of the floods on the metallurgical coal operations is no longer an issue (although industrial action remains one) and operations in the Gulf are normalising. As those businesses get back to generating the earnings they are capable of, they will give the overall group a significant boost.

The core of the group's earnings remains its iron ore, petroleum and coal operations. Iron ore earnings were up 36 per cent, petroleum's 38 per cent and metallurgical coal 5.8 per cent. Their performances helped offset a 54 per cent fall in the EBITDA of the group's base metal businesses as a result of the issues at Escondida and lower metal prices. Aluminium is also struggling and actually lost money in the half.

In the near term, provided China's demand for steelmaking materials holds up, the massive increases in iron ore production that are occurring and BHP's dominant position in metallurgical coal will continue to underpin its earnings.

The coincidence, or not, of Rio Tinto's announcement today of another $US3.4 billion investment in its Pilbara operations is another indication of the confidence the two big iron ore miners have in the sector.

BHP's view is that the rate of growth in demand for steelmaking raw materials will eventually decelerate but that the fundamentals for those commodities will still remain robust. Both BHP and Rio are of the view that the need for new supply – much of it from new higher-cost mines – will protect the volumes and margins of the low-cost producers.

The diversity of the BHP portfolio – its copper, energy and potentially potash exposures – also means that it has developed a hedge in the event that China's growth curve shifts its emphasis from steelmaking for infrastructure towards more consumption-intensive commodities.

Prices might have softened through the half-year but, relative to the previous corresponding half, BHP still benefitted from higher prices to the tune of about $US2.8 billion. That offset a slight decline in volume and a $US1.9 billion increase in costs, which included a $US597 million increase in labour costs. It is not news that the commodities boom is generating cost pressures.

While there might be those in the market disappointed that there were neither dividend increases nor any capital management initiatives, BHP now has about $US27 billion of development projects in its pipeline and a couple of mega-projects – the Olympic Dam expansion is the most notable – on the verge of entering it.

After its $US20 billion acquisition spree in the shale oil sector in the US, it also has gearing of about 25 per cent, although that's not any kind of issue given its cash flows and their resilience.

The interim result had some aberrational elements to it but the BHP growth story remains very much intact and its ability to absorb some of those issues underscores the strength of its diversified model.