BHP Billiton chief executive Andrew Mackenzie tells Business Spectator's Robert Gottliebsen and Stephen Bartholomeusz:
-- The demerger will allow BHP Billiton to evolve into "stunningly simple" company for its scale with a very small operating footprint
-- The narrowing of BHP's asset base is unlikely to have a material impact on the cash-flow risk
-- Giving every shareholder a pro-rated allocation of NewCo shares is a form of capital management that will please most shareholders
-- Diversification will allow the company to be more resilient to market shocks and to plan for the long term
Stephen Bartholomeusz: Andrew, thanks for joining us. You’ve announced this proposed demerger of a number of BHP’s assets, including some quite attractive assets. Could you briefly explain the philosophy behind the demerger and the decision to create this new entity, and the choice of the assets that you’re going to transfer into it?
Andrew Mackenzie: I can. We’ve been clear for the better part of two years and probably longer than that, and it’s just started very much under Marius, we saw real power in simplifying the portfolio and concentrating BHP Billiton on a small number of very large-scale, world-class assets, almost beyond Tier 1. We said strongly that it was going to be iron ore in the Pilbara, coal predominantly in Queensland, copper predominantly in South America and South Australia and then our petroleum business, with a potential fifth being potash.
We see that as the future for BHP Billiton, which allows us to effectively span steelmaking, energy and potentially food. We’ve embarked on the process of simplifying the portfolio. The first phase was very much through trade sales, businesses that we felt were trading at prices that reflected mid-cycle prices for their products. We were very successful: $6.5 billion dollars of sales, almost all of them achieved at prices that were probably north of the average of market expectations.
But we want to get to this simple portfolio quickly in the most value-adding way. We concluded for the majority of the remaining assets, it would be more effective to demerge them in the way that we’ve announced this week and then tidy things up at the margin with a few more trade sales of things like Nickel West, small-scale petroleum and what remains of our North American coal business.
That’s essentially how we selected the portfolio. You can see we’ve not included certain assets in there because they’ve been previously sold or are awaiting to be sold that we were thinking of a portfolio that needed to have assets which were smaller scale, but still high quality in world standards and in the industries in which they played. That’s what we’ve ended up with.
With this demerger, in all but a single step we get pretty close to what is the desired portfolio for the next stage of evolution of BHP Billiton, which I think will be a stunningly simple company for its scale with a very small operating footprint. But it will still be capable because of the output of that footprint to be a huge global player in resources and selling to the four corners.
SB: In the context of BHP and the basin assets that you’ve got -- I suppose you could call these assets second-tier assets -- there seemed to be a view in the market which I think is starting to drift away that they were also second-rate assets. I take it you wouldn’t view them in that light?
AM: I don’t like either ‘second tier’ or ‘second rate’. When you look at things like Cannington, the largest and probably most profitable silver mine in the world, things like Alumar and Worsley Alumina, these are huge, recently capitalised and in many respects top-quartile performers in alumina. I could go on. They’re just, for what we want to do as BHP Billiton, in general smaller scale. But in their industries, they are top-quality assets and very competitive.
The fact is that as a collection, even though the majority are trading at prices that people would say would be below their midpoint in terms of the cycle, they’re still generating a lot of operating costs -- $1.1bn in the year just closed -- with huge potential upside.
RG: Andrew, could I take you into some financial thinking? Australian institutions like capital returns. The Australian small shareholders much prefer higher dividends. Out of this, some of the institutions wanted their old capital returns, but you did not do that and are going to pay higher dividends. Is that a deliberate strategy to go on the side of smaller investors?
AM: We have many investors that we need to satisfy. You’re right: one of the most difficult things to do is, particularly when you operate as broadly as we have and have such a wide range of shareholders, which of course is partly facilitated by our dual listing, to have a capital management program that is absolutely what everybody wants.
We always have to find a way of doing as much as we can without compromising value to satisfy the largest number of shareholders. First of all, we announced an increase in the dividend by 4 per cent with these results and that is now giving a payout ratio of 48 per cent of earnings. That is top class within our sector.
You’re correct, Robert. We said that we would not rebase the dividend when the NewCo assets leave BHP Billiton. So, even though we’re losing, you know, a piece of our cash pool that could allow us to pay dividends, we will continue to pay the dividend at the level as it is today or announced with the results, so that will take the payout ratio into the 50s. It would depend at the time and so on and people can go and calculate it.
I would also argue that by giving every shareholder our pro-rated allocation of NewCo shares, that it is a form of capital management. People can either elect to retain the share because they believe in the potential of the company’s management to increase its performance, and possibly they have a in a line with the market, by the way, a positive outlook for the prices that NewCo products will sell at. Or they can crystallise that value by selling it for cash.
We’ve done an awful lot for a lot of shareholders at the moment and the company is doing very well in meeting the commitments we’ve made. At the full year, we over-delivered on productivity, we over-delivered on capital reductions, so our cash generation was greater than we thought was possible given the price deck at the half-year result.
All of this has gone to service these capital measures that we’ve just spoken about, but it’s also gone on to strengthen the balance sheet. Therefore as the balance sheet gets stronger, we have the potential for even more capital returns to shareholders in a form that satisfies the most people.
RG: But do you think that your dividend payout ratio will stay north of 50 per cent going forward?
AM: I don’t want to give a prediction like that. But if I look backward over 10 years, we’ve given $64bn to shareholders roughly at a payout ratio of about 50 per cent. About two thirds of that has come from dividends and a third has come from other forms of capital management, like buybacks.
SB: Andrew, for the best part of a decade and a half, BHP has pursued this diversified business model built around those concepts of cash-flow risk and base cash flows. Assuming the NewCo spinout occurs as planned, does the narrowing of the asset base have any impact at all on the cash-flow risk?
AM: I don’t believe so in a material sense. It’s a large company by ASX standards, but it’s quite a small part of BHP Billiton, so its ability to in some way diversify the portfolio at a cash-flow risk basis is somewhat constrained.
A lot of these products are not completely uncorrelated with each other; there’s a high degree of covariance. In many cases that covariance has perhaps got greater with time as markets have become more perfect and more open and more global.
But I think with what remains with BHP Billiton by having an exposure to steelmaking, iron ore and coal, energy, copper and all of the fossil fuels -- and then potentially in the long-term something in potash -- that is quite a big spread.
It does two things for us which we have to have from diversification. One is it helps smooth the cash flows, so that we can plan for the long term and we can do things through the cycle without having to sort of continually change direction in response to market shocks. Secondly, it allows us to think even longer term.
If the world continues to progress in the way we think about it where steelmaking may become less important, but still strong and growing and a lot of opportunity for us and consumption or high rising living standards, particularly with a growing population in Asia, becomes more critical, then that’s going to give the increased demand for energy. We’ve always said we’re not quite sure where the world wants to get its energy, so it’s good to have wide diversification in energy, which we have.
We’re in all forms. We’re in copper for transport, very important for energy efficiency and renewables, we’re in all the fossil fuels and we’re in uranium for nuclear power and we can swing our investments accordingly, so that’s a nice diversification as well.
Finally, if you think of a very highly efficient world where there’s perhaps less growth in the consumption of energy and people continue to improve their living standards by eating better, then we have the long, long-term option of being part of the food industry. That gives us all the diversification we want and then some, even after NewCo has left the portfolio.
SB: Had the demerger occurred beyond a year ago, what impact would it have had on BHP’s continuing financial metrics, the key ones?
AM: That’s a good question. Some of the strongest performance that we’ve announced -- very, very positive full-year results has actually come from the NewCo assets, aluminium and manganese and nickel -- even though they’ve got slightly depressed prices. Some of the coal assets have perhaps made the most progress in reducing unit costs and increasing their cash generating capacity in very difficult circumstances. There are other factors, of course, and price has made that harder.
And we’ve learned a lot as BHP Billiton outside of the NewCo company as to how we can improve things. There are quite a few things we’re doing at the moment in driving improved performance in iron ore that are derived initially from things that were pioneered by some of the NewCo assets. So, I think this is the right time to do it. The knowledge is there.
I don’t think doing it earlier would have changed the results very much. Now we’re ready to do it and now the two companies in one will be able to add their own special sauce and demerge BHP Billiton. As a result, performance in both areas will soar relative to being kept together.
RG: In the latest result…
AM They still do a great job, but we’ll now do an even better job.
RG: Andrew, in the latest results you improved your productivity by just a little under $7bn. How much further is there to go? Can you double that or triple it? By the sound of it, you probably can because a lot of it came in the NewCo assets.
AM: Not a lot. I don’t want to down the other four businesses. They’ve done a great job as well and they would be very cross with me if I agreed with you on that one.
RG: How much further to go?
AM: We’ve said we can do another $3.5bn on an annualised basis out to financial year 2017. This is now the guiding principle by which ultimately we want to grow this company. I’m not going to answer whether it’s doubling or tripling. I’ve been a bit bolder than I probably thought I would be in giving some forward guidance to the market. At the half year we said we will deliver at least this by the full year and we’ve beaten that, as I’ve said, by $1.1bn. We’ve given guidance for the next three years.
But I think it’s important because people need to understand some of the potential that’s unlocked by this demerger to increase productivity. We’re well into our agenda, but you know my way of putting it is that we have an awful lot more to do and an awful lot of other potential that you’re starting to see, broadly speaking, Robert. We’re very much going to try and get it as quickly as we can.
RG: Andrew, PricewaterhouseCoopers are scathing of the Australian mining industry for their productivity and that obviously includes you and if it’s anything like what they say, you should only be just beginning. There must be an enormous amount still to do.
AM: We use a lot of benchmarks and we can see a lot of potential. In some of those reports, which are scathing of Australian mining, there’s some good news in that as well. First of all these are based on obviously a lot of exchange rate assumptions and I sometimes think with things like this you’re probably better off using things like purchasing power parity and then the discrepancy is not as wide as some people would say, but nonetheless it is there. We all know that in the response to China, so we geared up very fast and in doing that we emphasised getting the volume on the ships and sold and perhaps spent not enough attention on ensuring that the volume was coming at low cost, but there were clearly skills shortages that inevitably meant that costs would rise. We’re through that now and the fact that Australia is a go-ahead country, very open to new technology, new ways of thinking and not an unreasonable amount of flexibility, then the stimulus of things like PwC means there is becoming an Australian response and in many ways what that will do is that it will create in terms of using technology -- the technology of big data, which we use through our systems, the technology of automation, better trucks and so I would overemphasise that Australia can still come back to lead the world in terms of productivity.
When you look at it on tonnes per activity or tonnes per people then we’ll see what the cost of those people turns out to be. But I think it’s important for Australia that we offer high paying employment in the mining industry. It’s not a high population country and we want to have well-paid jobs here, so we want to make those jobs incredibly productive through what we’re doing through our systems and our processes, which is most of the game, by the way, and then obviously the investment in leading edge technology as well, so I think it’s all to play for.
SB: Andrew, just to follow on from that, if you achieve the last $3.5 billion of productivity gains, you’ll have reduced your cost base, increased your volumes by a combination of about $10 billion over five years. What does that say about that boom era? And could you have done things differently in that kind of environment?
AM: Of course you could have. But you know nothing’s perfect. We’re always striving for low levels of imperfection and we shouldn’t be too hard on ourselves on the previous period because we’ve put a lot of the infrastructure in place quickly in a way that it’s provided the supply the world needed.
That’s been very important for things like geopolitical stability and Australia. The investors should feel very good about that and because that’s all sitting there now, we can do all these gains with productivity to achieve that capacity in a way that will provide a lot more supply and much lower capital intensity and a much lower cost that will create more sustainable pricing, which in turn will actually support further economic growth. I tend to be an optimistic kind of guy and that’s very much the way I see it. But seeing is believing.
It wasn’t so long ago if we were thinking about getting to 290 million tonnes per annum in our iron ore business, for example. We have looked at quite big capital costs and so on, but by just sitting back with what we’ve got and making what we’ve got much more productive, higher utilisation, fewer costs in achieving that utilisation. We’ve seen our way through to achieving that with minimal capital, so we may get there with a capital intensity of about $50 per annual tonne, which is world class as a number and that’s what’s possible in Australia and with some of the investments that have been made in the previous year. We’re seeing the same thing in coal and in time we’ll see that in some parts of the gas industry in this country as well.
RG: Andrew, is there any problem with potash? You seemed to slow down a bit this year in potash. And what do you think that will look like in, say, three years’ time?
AM: I’m not in a hurry in potash. It’s just something for the very long term. We want to create the opportunity to potentially build a business in the food sector, if we call that, on a scale of the business we’ve got today in iron ore, metallurgical coal, petroleum and copper. We’ve all but secured the resources to do that in what we think is the best undeveloped potash in the world in Canada but we do need to make some initial investments to be serious about this resource and to be serious to the people of Saskatchewan. It involves building a shaft, which sounds simple but people don’t build shafts that often. We need to take that time, get it right, use leading edge technology to reduce costs and we’re bringing in a lot of know-how from the rest of the mining industry, but also from petroleum because the shaft’s really just like a big well and petroleum can get it right.
To be honest, I don’t want the company to spend too much capital. If you can reduce the burn rate and do it even more effectively, then I’ll take that anytime because we’re still waiting to see when the market really sends the signals it wants a new greenfield mine and at any stage, once you have a shaft, you’re still three years from being able to turn first potash. It’s a long process and by going slow, we can wait and watch the market, we can keep our costs down and we can master new technology. But also while we’re doing that all the work that goes on to really think about how you build the mine, how you can do it with the highest capital efficiency and the highest guarantee that you’ll be able to execute against that can be done.
You talk about the rush and things not being done in the build-up of mining capacity in the more recent past. Well, run that forward, we now don’t need to rush so we can build in all those product savings from day one. We probably do test the patience of some shareholders and I’m very clear that this is something that we need to be modest about and we can only have one or two of those areas, even for a company like BHP Billiton. But in a way we’re doing the same thing at Olympic Dam, finding ways of developing this project over time with high capital efficiency by taking our time.
RG: So, Olympic Dam could be five years away, 10 years away using the same processes?
AM: We’ve announced a couple of things recently that we’re getting costs down to the levels of Escondida, which is the most important thing, so it’s getting competitive. We continue to have success with heap leach that will dramatically reduce the processing costs and we’ll talk about things during the course of this year about how we can in a more modest, but nonetheless, determined way continue to grow the output from Olympic Dam and think about this as a multi-decade type of endeavour working on one of the, if not the best undeveloped copper ore body in the world, or only partially developed, if you like, but you know we’re now a very small part of it with the underground at the moment.
RG: Thank you, Andrew.
SB: Thanks, Andrew.