BHP is our lucky company. If it were not for that luck, combined with a strategic retreat from major expansions, the legendary hedge fund manager Jim Chanos would now be shorting BHP Billiton rather than Fortescue Metals.
As Kirstie Spicer reveals in her Markets Spectator commentary (China bear Chanos is betting against the miners, September 26), Chanos believes the iron ore market is going to be oversupplied given the big rises looming in iron ore production and the sluggishness in China demand. Chanos is the hedge fund manager who picked the Enron debacle.
Last night I spent time browsing the BHP annual report and I could not help feeling that the Big Australian has two weaknesses that nearly brought it to grief.
Its first weakness is that in the last half decade it forgot its own history and it went close to repeating the 1990s mistakes. The lessons of history are usually more important than listening to young analysts in determining future strategies.
BHP’s second weakness is that it is not as good at mining as it should be. It will need to rectify both weaknesses if it is going to prosper in the world that Chanos believes will unfold.
And while BHP is not nearly as bearish as Chanos it also alerts its shareholders that the next year or two the market in commodities could be tougher (BHP warns on commodities, September 25).
Recently BHP announced it was shifting its head office back to Collins Street, Melbourne – close to where the company started. That encouraged me because, like many Australian companies, BHP has been running away from its history for too long and that lack of historical knowledge almost brought on another disaster.
The latest BHP balance sheet shows that in 2010 BHP had a gearing ratio of 6.3 per cent. Three years later, in 2013, the gearing ratio was up to 28.8 per cent after investment of close to $70 billion. Profit in 2013 was lower than in 2010.
Gearing below 30 per cent is not high but in the last half decade or so BHP made four major thrusts: Rio Tinto (which might have saddled it with Rio Tinto’s aluminum mess); Port Hedland outer harbour (it would have been a disaster if Chanos is right); the Olympic Dam expansion (too costly, plus it faces technological barriers); the takeover bid for Canada’s Potash Corp, which was also too costly given the later break-up of the cartel;and the deal that did come off, shale oil and gas in the US, which turned out to be the winner of the five projects BHP looked at.
Had one or two more of these expansion thrusts gone ahead the BHP gearing would now be very different and BHP’s history shows that when the company takes on too many projects at once it falls over.
Historically BHP’s iron ore mine management has not matched the productivity of Rio Tinto. In coal private equity groups want to get hold of the BHP closed Norwich Park mine because they believe that using modern mine management and independent contracting (now encouraged by Canberra) they can re-open Norwich Park and make it very profitable.
And of course the opportunity to boost profitability of the existing coal mines is even greater.
BHP chief Andrew Mackenzie is looking to achieve much lower cost levels, with BHP making the mining management changes itself. That will not be easy but the good news is that he recognises the problem.
Call it luck or call it good management but BHP did not undertake any of the four major projects that would have hurt it and now is well placed should Chanos be right.
And, despite what analysts say, BHP can’t stand still for ever. History tells us that BHP makes its big long-term gains by making major expansion moves in tough times. All BHP executives should study the work of the BHP greats – Essington Lewis, Ian McLennan, James McNeill and Brian Loton – plus those that made mistakes. In other words, know the lessons of the BHP history. Long-term shareholders will be the winners.
Footnote: A trivia question for all BHP executives and directors: Who used the saying "buying straw hats in winter" and how did he use it to transform the company?