Miners pick off low fruit to fill coffers
BOTH Australia's mining heavyweights - BHP Billiton and Rio Tinto - announced asset sales on Wednesday which were large by most company standards.
But for these two the deals which raised respectively $US1.63 billion and $US373 million look more like a bit of portfolio spring cleaning.
But there is nothing co-incidental about either picking off the low-hanging fruit to raise cash. Industry experts have been predicting that 2013 will be a year when there will be plenty more asset sales by the miners who will be using all means available to boost their cash coffers.
They have dividend payments to sustain during a period where weaker commodity prices will translate into cash flow strains.
These companies generate enormous profits but they also have huge capex requirements that eat into the cash and limit what is left to pay dividends to shareholders.
There has long been a tussle between the boards of these companies and their shareholders around the allocation of cash between reinvestment in projects and better dividend returns.
In recent years the companies have given some ground to shareholder demands for a better dividend and BHP regularly defends its current payout ratio by claiming it is the best of its industry peers.
But it has also had a long tradition of not cutting its dividend regardless of its profit or the point in the commodity cycle.
It is a constant balancing act.
BHP also boasts that it has been a counter-cyclical investor - one that retains a relatively high levels of investment when commodity prices retreat. This was certainly the case during the global financial crisis and it has paid off by helping the company increase volumes to offset some of the impacts of lower commodity prices.
But the reality is that at both BHP and Rio choices are being made about how to ride out the current slump.
Plenty has been said by the companies and experts about scaling back on new and costly projects, but the desire to maintain a certain level of capex to fund future growth has meant neither company can simply turn off the tap on investment.
This leaves resource companies with the dilemma of how to retain sufficient cash to maintain dividend payments at levels that match those of the 2012 financial year.
There is always the option of funding dividends through debt but this strategy could only work on a short-term basis. If resource companies take the view that there is a structural decline in commodity demand it would be reckless and short-sighted to engage in a short-term solution.
Taking on addition borrowing will also threaten debt ratings, which in turn would increase the cost of debt.
Some initial easy runs can be scored by cutting costs, but there is a limit and it is close to being reached. It also won't be enough.
Capex sacrifices will need to continue and ultimately so will selling assets that don't meet the cost of capital or can be called non-core.
Aluminium, diamonds and small non-controlling interests in just about anything top the list.
Executing an asset sale strategy has its own set of challenges - the biggest of which is finding a buyer for the assets among an equally challenged set of counter parties.
PetroChina has stepped up to the mark to take BHP's minority stake in two parts of the Browse LNG project, but again this is low-hanging fruit and the transaction doesn't really move the dial for BHP.
It is the big ticket items that will make the difference. This explains why investors are sour about BHP's $20 billion investment in oil/gas shale asset in the US.
While these acquisitions may ultimately enhance the longer term growth prospects for the company, investors are more concerned that in the shorter term they are capex heavy and earnings light.
BHP would have been more readily forgiven for this investment in an environment where no trade-offs were involved.
BHP boss Marius Kloppers may ultimately be the hero but in the short-term world of investors, the funds employed to buy and develop these assets would have been better utilised returning money via dividends.
The investment in Canadian potash has been better received and understood by the market in part because it is not as capital intensive.
The good news for investors in the major mining companies is that in recent months the share prices have gone for a run. The slightly improving outlook from China has fuelled positive sentiment around the prospects for the major mining companies that were arguably oversold in the first half of the calendar year.
But this won't solve the cash problem in the short term.
Next year will be one in which the miners will need to take a second and a third look at their portfolio of assets - and some are sure to be placed on the block.