THE DISTILLERY: BHP funk

BHP Billiton's results and Olympic Dam decision were well flagged to the market. However, in this edition of The Distillery, Australia's business commentators give the occasion a proper context and a few details that the predictable headlines can't.

The Australian's economics editor David Uren delivers the goods by stepping back into September 2009 when then Rudd government announced the $43 billion Gorgon gas project. At the time, it felt like Australia's resources boom was going to cannon right through the GFC and its aftermath.

"Until Gorgon was announced, Woodside's North West Shelf had been Australia's biggest single project. The past five years have been like six or seven North West Shelves. The Olympic Dam project was never on that list of firm projects. It was always a highly ambitious undertaking, among the largest earthmoving projects in history. It could yield vast profits eventually, but only after many years of costly toil. It was always going to require a board that was extremely confident of its markets, capital costs and engineering. BHP Billiton's decision to shelve the project nevertheless marks a turning point in the resources boom. The confidence in the outlook for commodity markets has been shaken and capital markets have become warier. Had Olympic Dam come before the board a year ago, it likely would have been approved.”

Fairfax's Malcolm Maiden isolates the claim that BHP will look at "an alternative, less capital intensive” open-pit design at Olympic Dam, to explain what that means in practical terms.

"The biggest cost in the project is digging the open-cut quarry. There is no way to significantly downsize project costs without reducing the size of the hole, and the amount of overburden that needs to be removed before the ore body is exposed. The final outcome is in the hands of the markets and the copper price, but the full-blown open-cut idea may be dead.”

Business Spectator's Stephen Bartholomeusz says readers and investors only need to look at one particular line of the BHP results to see why chief executive Marius Kloppers mothballed the mega-project.

"In the year just ended BHP's interest-bearing liabilities increased from $US19.3 billion to $US28.2 billion and while its gearing remains reasonably conservative at 26 per cent it simply doesn't have the surplus cash flows to fund those massive prospective projects. It isn't alone. All the major resource groups were caught unprepared by the rapidity and extent of the decline in commodity prices that has occurred as China's economy has slowed in response to the woes within the eurozone and the sluggish state of the US economy. BHP, Rio Tinto, Vale, Xstrata, et al, are also shelving previously planned projects and adopting a far more defensive stance as it has become apparent that the ‘super' element of the commodity cycle and the windfall price-driven cash bonanzas it generated has ended.”

The Australian Financial Review's Chanticleer columnist Tony Boyd says Kloppers has secured his job at the top of Australia's biggest company, but he needs to address the miner's underperforming businesses.

"He now needs to turn his attention to the handful of BHP projects earning woeful returns. In the year just ended, BHP earned only $US175 million in underlying earnings before interest and tax from four businesses that had combined revenue of $US11.2 billion. Dealing with aluminium, which lost $US291 million, diamonds, which made $US199 million, stainless steel materials, which made $US32 million, and manganese, which made $US235 million, would transform the company's returns. In the year to June BHP reported an underlying earnings before interest and tax margin of 39 per cent and a return on capital of 23 per cent, which was in line with expectations. However, BHP's result was already loaded up with $US3.48 billion in exceptional items to cover impairments for shale gas, nickel and suspension or early closure of operations and delaying Olympic Dam.”

Questions about Kloppers have grown louder since the miner's foray into US shale gas, which accompanied a collapse in the price of US gas. While many site that as the executive's biggest mistake, Business Spectator's Robert Gottliebsen takes has another take.

"No, BHP's first hidden mistake was much bigger. Towards the end of 2010-11, BHP spent almost $10 billion buying back its stock at prices inflated by the boom. It was a bad mistake by the BHP board and against the advice of a number of the wiser Australian long-term institutions who told BHP in no uncertain terms to lift the dividend instead of buying back shares. Instead Marius Kloppers and his board paid $40.85 a BHP share for most of the stock (the shares were higher at the time) and since then they have seen BHP shares slashed in price. BHP shares are currently around $33 which means that BHP shareholders lost a massive $1.8 billion on the deal. When BHP shares were around $31 a few weeks ago the loss was approaching the US writedowns.”

On the positive side, The Australian Financial Review's Mike Smith stresses that BHP's outlook is a bit more encouraging than usual. But it's a qualified boost for the miner.

"While most of the bad news had already been flagged, the slump in earnings does not leave BHP in a sweet spot compared with its prime position after the global financial crisis when Kloppers appeared to have the world at his feet. Shelving Olympic Dam also reinforces BHP's history as taking an over-ambitious approach towards big-ticket projects. The ghost of the company's $3.2 billion purchase of Magma Copper in 1996 still haunts the company. Coming on the back of a string of embarrassing investments, that investment was written off and cost former chief executive John Prescott his job in 1998. Kloppers is not in the same boat as Prescott at the moment and the board has made it clear he still has its support. Some of BHP's setbacks have also been outside his control.”

The Australian's Barry Fitzgerald says the decision by Kloppers to walk away from the Olympic Dam expansion "is not as clear-cut” as dumping the bid for Rio Tinto in late 2008. But the respected resources writer adds that he still had no choice in the end.

Alexander Downer, Former Foreign Minister and Member for Mayo, a seat east of Adelaide, writes in The Advertiser that BHP's decision is the biggest setback for South Australia since the collapse of the State Bank.

Downer's doesn't offer much financial insight from BHP's perspective. But he does argue that the loss of business confidence and government tax collections will force a significant redrafting of the economic plans of Premier Jay Weatherill and Opposition Leader Isobel Redmond.

The other big corporate story to emerge yesterday was the departure of Pacific Brands chief executive Sue Morphet after a rough five years.

Fairfax's Adele Ferguson argues that replacing Morphet with former Foster's Group boss John Pollaers is the "first smart move it has done in a long time”.

It's fair to say that Ferguson is a critic of Morphet's strategy to open retail stores and shift labour to China as the first didn't work for Billabong International and the second came too late.

The Australian's John Durie reports that Morphet has had enough at the helm of Australia's slowly sinking underwear company Pacific Brands. Floated eight years ago for $1.3 billion, the company's value has slipped to $527 million. A shining light is that debt is down to $189 million from $466 million.

Morphet will be remembered unfairly as the clothes-manufacturing boss that sent jobs to China while accepting a massive pay increase. It's unfair, because the pay rise was due to her elevation to the position of CEO and she's about the last clothes manufacturer in Australia that has any jobs left to send to China.

In other company news, Fairfax's Ian Verrender retraces Coca-Cola Amatil's path into the brewing industry, a path that CCA itself is about to retrace.

Elsewhere, The Australian's Robin Bromby reports that production of gas cookers has fallen by 28 per cent.

And finally, The Australian's Asia Pacific editor Rowan Callick says Australia's reluctance to open itself up again to international arbitration is a significant issue of contention in establishing free trade agreements with Asian neighbours.