The Distillery: Resource rethink

Over the weekend, business commentators offered us reflections on a week that included the latest production reports from the big miners and a cataclysmic announcement from Orica, a company tied somewhat to their fortunes.

The broad conclusion is that the big miners are well prepared for China’s slowdown and that this isn’t so much an end to the boom, but an evolution of it. Nonetheless mining companies and their supporting cousins aren’t going to reap profits as they have in previous years. The price you pay for failing to be on top of your business is huge.

Firstly, The Australian’s Barry Fitzgerald notes that the June quarter reports from BHP Billiton and Rio Tinto more than anything else underline the “new era” of prudence over expansion.

“The focus now is very much on ‘sweating’ the enlarged capacity base put in place during the unprecedented investment splurge on new capacity across the past 10 years. Where companies used to wear their capital expenditure commitments to new capacity as a badge of honour, pride is now taken in how much capex has been reined in, and how much production has grown from capital invested in previous years. The transition from an investment-led charge by the industry to a production-led focus has not been enough to protect the resource sector's profits in the June year/half. But because of the massive decline in capex commitments, investors can look forward to improved dividend returns, particularly when the benefits of the falling dollar and easing cost pressures for labour, materials and equipment are added in.”

Fairfax’s Malcolm Maiden brings word from Goldman Sachs, the investment bank that first predicted the rise of the BRIC nations (Brazil, Russia, India and China), that the resources super-cycle is far from over, but it is “evolving”.

“The investment bank does not believe newer emerging economies including India, Bangladesh, Egypt, Indonesia, Iran, Mexico, Nigeria, Pakistan, the Philippines, Turkey, South Korea and Vietnam can replace China's infrastructure boom for intensity. It does, however, believe there is enough demand coming through to keep the demand-supply equation tight and the super-cycle alive. Mining will be harder to do in the next decade of the super-cycle as environmental concerns grow and development approvals become more time consuming. It's going to be increasingly a game for heavyweights, too. The size of individual projects will continue to grow to lock in economies of scale, and the big groups that have the funding lines will dominate.”

Which brings us to Orica, a company that is hardly one of the big resource houses. The Australian’s John Durie illustrates the job ahead of Orica boss Ian Smith – once the darling of the gold industry as Newcrest boss, until the post-Lihir purchase era kicked in.

It was thought that Orica would be “somewhat immune” from the easing resources boom because its explosives business could ride it out.

“The collapse of US gas prices hit that theory because cheap energy meant coal demand collapses, although Smith was talking up the US yesterday. In typical Smith style, the real cause of the profit downgrade was hard to fathom because it was sheeted home to many factors from problems in Indonesia, to higher-than-expected integration costs and weaker-than-expected demand. Take your pick, but integration costs is as good as any because it continues the line that past management wasn't doing the things it should have to make the most of its overpriced Minova acquisition. The admission that profits will be 10 per cent below last year's effort added to the sense of gloom ahead of the upcoming reporting season.”

The Australian Financial Review’s Chanticleer columnist Michael Smith explains how Orica’s episode on Friday serves as a reminder to company boards that are sitting on bad news in the lead-up to their profit reports.

“Directors are particularly worried at the moment about litigation funders with deep pockets, what with gold miner Newcrest facing a potential class action over its disclosure practices. It is a delicate balancing act. Move too early and you risk undermining your company’s share price with information that has not been thoroughly checked out. There was a grim reminder to boards on Friday about how a jittery market will react to an earnings downgrade when shares in explosives-maker Orica fell 15 per cent on a 10 per cent cut to forecasts. Leave it too late and the shareholders and regulators will be baying for your blood. Not everyone is erring on the side of caution though.”

In other company news, Business Spectator’s Stephen Bartholomeusz says the greatest loss for Woolworths from its botched rollout of hardware chain Masters is not to its bottom line, but its reputation.

Fairfax’s Adele Ferguson is back on the Commonwealth Bank financial trading scandal, this time through the prism of Nationals senator John ‘Wacka’ Williams, who is having a crack at the corporate regulator after a bunch of retirees lost their savings.

Elsewhere, The Australian’s economics editor David Uren writes that the Reserve Bank of Australia and Treasury are reviewing economics forecasts they made just two months ago, as they face the question of whether these need to be downgraded.

And with growth forecasts in mind, Fairfax’s Ross Gittins puts on a clinic in growth, debt and deficit that puts both current treasurer Chris Bowen and would-be treasurer Joe Hockey to shame.