Mackenzie feels the resources pinch

BHP and Rio Tinto are Australia's two mining whales, and they are swimming through similar, slightly chilly water this year as the resources bubble deflates and they focus much more tightly on costs and productivity.

Investors are taking on different risks depending on which whale they ride. Rio is the biggest punt on the iron ore price. BHP is a more evenly weighted bet on a basket of commodities, and a less risky conveyance as a result.

BHP's 31 per cent lower June year underlying net profit of $US11.8 billion missed the consensus forecast of $US12.6 billion, but chief executive Andrew Mackenzie says the group hit the mark on higher-level profit lines, including 15.9 per cent lower earnings before interest, tax, depreciation and amortisation (EBITDA) of $US28.4 billion.

Several BHP businesses made big contributions to the result, as usual. Iron ore EBITDA was down from $US15 billion to $US12.2 billion, but it was still the biggest business, contributing 42 per cent of total earnings at the EBITDA level. Oil and gas EBITDA edged down from $US9.1 billion to $US8.8 billion, 31 per cent of the total. Copper earnings eased from $US4.7 billion to $US4.6 billion, but were still 16 per cent of EBITDA. Coal is usually another big piston in BHP's engine, but this year its contribution fell from $US3.6 billion to $US1.7 billion, 6 per cent of total EBITDA.

Lower prices including a 17 per cent lower iron price cost BHP $US8.9 billion during the year. It saved $US2.7 billion with cost cuts and productivity gains including labour productivity gains of $US458 million, however, and its broad portfolio of commodities ironed out profit volatility.

The 18 per cent lower underlying profit of $US4.23 billion for the June half that Rio announced a week-and-a-half ago was by way of contrast pretty much a single-piston effort. Rio's iron ore business posted a decline in EBITDA from $US10.1 billion to $US9.6 billion, but it still generated 65 per cent of the group's revenue, and 79.5 per cent of Rio's total EBITDA.

The aluminium business that Rio dramatically and tragically bulked up in 2007 with the $US38 billion takeover of Alcan contributed 13 per cent of operating revenue but only 7.1 per cent of EBITDA. Rio's copper division contributed 29 per cent of revenue, but only 9.3 per cent of EBITDA. Energy coal and uranium contributed 4.1 per cent of EBITDA, and Rio's diamonds and minerals division contributed 6.5 per cent.

Rio is a more profitable iron ore miner. Its EBITDA-to-revenue ratio of 65 per cent in the June beat BHP's iron ore EBITDA-to-revenue ratio of 60 per cent in the year to June, and it generated an outstanding annualised EBITDA yield of 71 per cent on gross assets employed: BHP's EBITDA return on its iron ore assets was lower at 44 per cent, albeit still an object of envy in the corporate world.

The huge weight of the iron ore business inside Rio combined with better prices to produce solid numbers at group level in the June half year. Even as it carried its muscle-bound aluminium division, it managed a 28.4 per cent annualised return on operating assets, and its EBITDA-to-revenue margin was 36.1 per cent.

BHP's overall return on assets employed in the June year was lower, at 20.5 per cent. Its overall EBITDA-to-revenue margin was better however, at 45 per cent: on balance, it is a more balanced business.

Rio's big iron ore weighting is assisting the group this year because the iron ore price is refusing to fall. It slipped from just under $US159 a tonne to $US113.80 a tonne between February 20 and June 26 this year, and there were predictions that it would sink well below $100 a tonne in the December half as Chinese steel mills implemented a seasonal production slowdown. Since the end of June it has rallied again and it was trading at $US139.20 a tonne on Tuesday when BHP reported.

Most iron ore observers still expect the iron ore price to weaken in the medium to long term as supply expands and recycling accelerates. If it happens, Rio will be more exposed than BHP.

Rio is increasing its copper exposure with the giant Oyu Tolgoi development in Mongolia. But it is proving to be a politically complicated process and in the meantime BHP is lining up new diversification options, with Mackenzie announcing on Tuesday that the group will invest $US2.6 billion to finish digging shafts that prepare its Jansen Potash mine in Canada for a production green light - and develop the project to a point where BHP has a better chance of attracting joint venture partners to help fund a push to production.

The Maiden family owns BHP shares.

mmaiden@fairfaxmedia.com.au