Making BHP more like CBA

As we reach the end of the tumultuous 2012-13 financial year, let us take a step back and look at what is happening to our two largest companies – Commonwealth Bank and BHP.

A few years ago BHP towered over the Australian sharemarket and “The Big Australian” was our unchallenged largest company. But, in more recent times, the Commonwealth Bank has been a much better performer than BHP and has taken over the top mantle.

In a strange way BHP is now copying the strategies of the Commonwealth Bank, and when China gets through its current turmoil – and that might take a few years– BHP may once again regain the top position.

So what was the key to the CBA strategy that gave it top spot, and how does a resource company copy a bank? CBA has always had a fantastic customer base in much the same way as BHP has had a fantastic set of mineral deposits. But CBA has had a series of chief executives who began working at making the bank and its customer base far more productive. BHP took the reverse strategy and tried to dramatically expand its customer base equivalent – production from its mineral deposits.

The new breed of CBA chiefs started with David Murray, who invested heavily in technology – more than any other bank CEO of the day. Murray’s successor, Ralph Norris, went even further so, as a result, when the current CEO Ian Narev took over, his task was to harness the technology investments made by his predecessors to make the bank far more productive and efficient.

Now, of course, that involved enabling staff to undertake more tasks, but it also involved selling different products to the same customer base. The bank effectively expanded without using capital.

Because the CBA did not need to invest large amounts of its profit in capital works, so it could afford a high distribution policy. And when yields began falling on term deposits and other interest-bearing securities, investors turned to bank shares, and in particular the Commonwealth Bank, to gain yield. As they did that, CBA shares rose and BHP was relegated to second place. The greatest risk the CBA and other Australian banks face is that there will be a rise in Australian unemployment, which will boost bank bad debts and lower profits, and therefore lower dividends.

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BHP has traditionally adopted a very different strategy. Each chief executive of BHP, for as long as I can remember, was given the task of handing to his successor more ore reserves than he received from his predecessor.

BHP chief executives would proudly parade to shareholders the list of projects they had going forward. Six weeks ago, Andrew Mackenzie became the latest chief executive of BHP. Effectively his brief was to make BHP more like the CBA although, naturally, the new BHP strategy was not expressed in those terms.

The BHP change of direction actually started in the final months of his predecessor, Marius Kloppers. Mackenzie’s task is to carry it out. BHP looked at the huge number of future potential projects and simply put all of them on hold, except those that were already well on the way. And so BHP mothballed Olympic Dam, even though it had virtually committed to the South Australian government that it would go ahead. Under the proposed Olympic Dam plan, for some six years BHP would spend vast sums digging an enormous hole to get at the ore body – an activity that would not produce revenue during those six years.

Just as bad, BHP had not developed low-cost techniques to reduce the uranium content to enable the Olympic Dam concentrates to be shipped. The idea was that the technology breakthrough would be made during those six years of uninterrupted digging. It was classic, traditional BHP. Olympic Dam will eventually be developed, but the mining process will not involve six years of overburden removal without revenue, and the technology problems will be solved before construction starts.

There was also an ambitious plan to expand BHP’s Outer Harbour iron ore facilities at Port Hedland. Again, it was an enormously expensive project and although considerable work had been done, it was also mothballed. Other projects were also put on hold, but BHP is completing those projects that were started earlier.

It will take a few years, but Mackenzie plans a totally different approach to exploration and capital investment. A much greater percentage of BHP’s cash flow will go to shareholders, although remember that the resources boom is over, so there will be less overall cash flow.