Why BHP's shareholders missed the boat

This year's version of PricewaterhouseCoopers' annual global mining report is entitled ‘'The growing disconnect,'' which is a reference to the divergence of the big miners' strategies and their shareholders' demands and the market's expectations. From Marius Kloppers' comments today, a meeting of minds is rapidly occurring, although perhaps not quite as envisaged by shareholders.

In the earlier part of this year the contest of ideas between the companies and their shareholders has been as PwC describes it.

Coming off a remarkable 2011, when the revenue for the top 40 miners, PwC says, grew 26 per cent, cash flows 34 per cent and profits 31 per cent (to $133 billion,), the miners were committed to a massive investment program to increase their production and take advantage of the boom. After investing $98 billion in 2011, the top 40 planned $140 billion this year and had announced spending totalling $410 billion, the firm says. Shareholders, however, had something different in mind. With equity markets retreating, bonds producing minuscule returns (negative real returns in some jurisdictions) and defined benefit funds desperate for income streams, the shareholders have increasingly wanted the miners to stop spending and start distributing their excess cash flows.

It would appear they are going to get half of what they were demanding. The miners are cutting back heavily on their planned spending. It is unlikely, however, that the shareholders are going to see much more cash, either through increased dividends or capital management.

According to Kloppers, BHP Billiton, which once boasted an $80 billion pipeline of new projects through to 2015, now has no plans to approve any of its mega projects – Olympic Dam, the Outer Harbour at Port Hedland and the Jansen potash project in Canada – before December. It is generally considered unlikely that BHP will give a go ahead to more than one of those projects in the immediate future and possible that all three will be deferred until conditions improve.

The evolving change of stance from aggressive growth to defensive caution hasn't been driven by the shareholder agitation for bigger returns, but by an abrupt change in industry circumstance.That's partly due to the impact of the eurozone's difficulties on global economic growth and markets and partly due to the slowdown in China as the authorities there acted to dampen inflationary pressures. The end result has been lower commodity prices and, with costs escalating and the miners having struggled to get the new supply into the market a significant slump in their cash flows.

BHP is, having spent $US20 billion last year expanding into the US shale gas sector, which is itself capital intensive, particularly constrained. It simply wouldn't have the surplus cash flows to maintain the capital expenditure plans it envisaged a year ago. Rio Tinto, having executed its expansion of its high-margin iron ore business very efficiently so far, might have a little more flexibility.

The companies, however, will be cautious and risk averse until the eurozone instability is resolved, one way or another, and it becomes more obvious whether recent attempts by China to reverse the slowdown in its economy have succeeded.

From a longer-term perspective of course, the interruption to supply created by the uncertainty and lower commodity prices helps the biggest miners with the lowest-cost and highest-quality resources and will help put some kind of floor under commodity prices, albeit perhaps at lower levels than they have enjoyed in the recent past. Emerging competitors like Fortescue are also rapidly scaling back their expansion plans, while some new resource provinces may not be developed at all.

The $410 billion queue of projects PwC says had been foreshadowed is going to shrink quite dramatically, particularly as all but the largest miners tend to need good access to equity and debt markets to fund their developments.

The market generally read the tea leaves better than the industry. Last year, when the big miners were still generally very bullish, the sharemarket retracted, PwC says, all the gains in market capitalisation the 40 biggest miners had made in 2010.

The shareholders in the mega miners who dominate the sector – BHP, Rio, Vale, Xstrata and Anglo American – may have missed the boat.

Their pleas for less spending and more cash should have been made in 2010 when it appeared the boom might last well into this decade. Today the miners' spare cash will be used to shore up their defences against another severe outbreak of global financial crisis and recession.