BHP's message to investors

Summary: BHP is becoming very cash rich and seems well-supported by higher commodity and oil prices, in addition to greater demand for renewables. On a separate but related note, with the risk of war escalating, and where historically we would have seen a flight to precious metals, we're seeing demand for other safe havens.  

Key take-out: Right now, investing in brownfields expansions and distributing rewards around the community, as well as to shareholders, is the most popular course of action for cash rich large corporations like BHP. Investors should be aware they are unlikely to be the key beneficiary of these pursuits.

When large corporations are cash rich they usually embrace one of three strategies. 

First, they may announce vast new projects to lock in future growth. Currently, this is not a popular strategy and companies embarking on such a course are being treated badly by the market. One of the best recent examples is former Xstrata boss Mick Davis, who wanted to chair Rio Tinto but missed the job because the board did not want to pursue that first option.

Secondly, companies may tantalise shareholders with the offers of big cash rewards through higher dividends and/or capital returns. That is what shareholders want right now. One day, of course, the pendulum will swing back to option one, but today is not that day.

Instead, the third option is going to be the most popular investment course for the time being. Companies are going to invest in highly profitable so-called brownfield expansions of existing operations plus much greater technology to lower costs. Sometimes, these rewards will be distributed around the community as well as to shareholders. 

This week at the Melbourne Mining Club a large number of mining groups and investment houses assembled to hear BHP chief executive Andrew Mackenzie, and were on the edge of their seats wondering which way BHP would go. 

As everyone knows, BHP is setting itself up to become very cash rich. Just to remind you, the figures to June 30, 2017 showed BHP had net borrowings of $US16 billion, which was a huge reduction of $US10 billion from the previous year. 

This current year BHP's cash flows are again strong, but, at the top of its agenda is the sale of its US shale oil and gas interests. When BHP announced it intended to sell its US shale stake, the market assumed the company would receive around $US8 billion. Oil prices have since risen to give BHP a potential tailwind, and now the company is expected to receive at least $US10 billion for its stake. That takes debt down to $US6 billion; for BHP, that's a token level and way below its debt target. 

Much to the disappointment of BHP shareholders in the Melbourne Town Hall, Mackenzie did not mention shareholder rewards. Instead, he talked about spreading the rewards around the community, cementing BHP's long-term franchise at a time when there is great anti-corporate and anti-mining activism. 

We all know that BHP is planning major investments in Olympic Dam, the Spence copper mine in Chile, again at the Gulf of Mexico, and in a Canadian potash project. These aren't huge investments though — at least not at this stage. The BHP cash flow is pouring in because of the improvement in commodity prices. 

In terms of investment, what Mackenzie focused on was not big projects, but technology and innovation to substantially increase productivity and lower costs. BHP believes that, like the banks, it can revolutionise its operating structures and methods. That is its focus.

Meanwhile, Mackenzie is a huge fan of copper and he believes that copper will be BHP's ticket to participate in the boom of renewables and electrification. That is why Chile is so important to BHP and Olympic Dam is also a vital investment project.  And, of course, Mackenzie has BHP's interests in the giant Resolution Copper mine in the US in his back pocket. 

President Trump's tax cuts and, more particularly, his write-offs for new investment will greatly help BHP justify investing in Resolution, assuming the copper price rises as Mackenzie expects. BHP almost spun off Western Mining's old nickel mine at Kambalda to South32, but it remained in the BHP fold. Kambalda will be a major beneficiary from the battery revolution. 

Mackenzie believes that as we reengineer the world for renewables it will require big demands of steel, so he is optimistic about the commodities outlook for BHP. 

He also clearly wants to position the company to be a beneficiary of China's ‘One Belt One Road' initiative. In his address he said very friendly things about China and the way it operates. He is clearly trying to play to both the west and the east, which is the way Australia in general needs to approach the matter. 

War and bitcoin

President Trump has moved his tax package much closer to fruition, but the morass that involves the FBI and Russia is making markets very nervous. 

The response to the tax package has been much more muted than expected, and it now seems the positive impact will take longer to kick in. 

In the same breath as Trump, now to the risk of war. During the week I had the chance to speak with members of the defence community and it is clear they believe the chance of hostility escalating somewhere in the world has greatly increased. It could be in North Korea, but risks are also rising in the South China Sea, the Middle East and the Baltic region. And these are not the only hot spots.

Markets have not priced in this risk, so if war escalates there will be a correction of some magnitude. Traditionally, an increase in military activity is good for gold and oil. It will certainly be good for oil if that increase in activity is in the Middle East. 

Whether gold benefits will partly depend on just how much bitcoin and other cryptocurrencies take away from its status as a safe haven for money. I am not an expert on cryptocurrencies and I know there are a great many fans that are enthusiastic about their future.

But this week a taxi driver asked me whether he should invest in bitcoin.  

Not to be unfair to taxi drivers, it is just a sign the bitcoin boom has captured people with no experience in such matters. In past eras gold and other minerals have captured them. 

Once investment booms spread to non-investment people there is usually a correction. For me it was a warning sign, which I pass on.