Woodside warmth won't heat mining stocks

Woodside's special dividend was possible because of its balance sheet particulars but should not be seen as an omen that the likes of BHP Billiton and Rio Tinto will start handing out cash.

There’s been a bit of premature celebration in the wake of the $520 million special dividend and higher payout ratio that Woodside Petroleum announced this week by those anxious to see its capital management program as a tipping point in the struggle for cash between resource companies and their shareholders.

While there is no doubt that BHP Billiton and Rio Tinto are very aware of the demands from their shareholders that excess cash flows should be distributed rather than spent, the difference between those companies and Woodside is that they have no excess cash.

That has been a major factor in their decisions to shelve planned investments, slash operating costs, sell assets and introduce new disciplines on deployment of capital – and perhaps change their senior managements.

In the year to December, Rio, for instance, saw its net cash flows tumble from $US27.4 billion in 2011 to $US16.5 billion. Its capital expenditure last year was $US17.4 billion.

BHP reported a near-halving of its net cash flows in the December half, down from $US12.3 billion to $US6.4 billion. Its capital expenditure in the half was $US12 billion.

By comparison, Woodside’s cash flows, under-pinned by production from its Pluto project, surged 55 per cent to $US3.5 billion in 2012. It has about $2.5 billion of cash in the bank and a balance sheet that could fund investment or an acquisition of perhaps $US5 billion without strain.

For it, a key moment was the recent decision to shelve the planned $US45 billion Browse Basin LNG facility at James Price Point in Western Australia. It is now considering other development options for the Browse Basin gas but it is obvious that is going to take some time and without any other major new developments in the pipeline it has significant excess financial capacity and a rather large hoard of franking credits.

That’s why paying the special dividend and increasing its target dividend payout ratio to 80 per cent, which is said it expected to maintain for “several” years, makes sense. It’s not talking about a permanent shift in the balance between investing in its business and shareholder rewards but of using a temporary hiatus in its investment pipeline to improve its financial metrics and provide a bonus to shareholders.

BHP and Rio, unless they can accelerate their asset sales programs, are in a different position – although Rio did increase its final dividend 15 per cent. They are groups driven mainly by commodities prices, which have fallen sharply, where Woodside’s earnings are effectively driven by the oil price.

BHP has said in the past that its current, heavily curtailed, investment pipeline’s funding requirement – currently more than $20 billion a year - won’t start to subside until 2015. Incoming chief executive Andrew Mackenzie won’t be able to do much about that given that most of the projects involved are well underway. He is most unlikely to turn off the $US4 billion a year BHP is spending to pull liquids from its vast US shale gas reserves, given their returns on capital and pay-back periods.

With commodity prices unlikely to retrace their falls, China’s growth rate slowing and a wall of new supply, particularly in iron ore and coal, approaching fast the mining houses are focused on getting their fundamentals in order for the post-boom period the sector is entering.

Beyond the cost-cutting and focus on more efficient use of capital, of course, both BHP and Rio do have large development options. Rio has the ramp up of the giant Oyu Tolgoi copper-gold project in Mongolia, potentially the giant Simandou iron project in Guinea and, perhaps, the Riversdale coal projects in Mozambique; BHP has the Jansen potash project in Canada and, more distant, the mega-expansion project at Olympic Dam on the backburners, among a multitude of others.

While shareholders want more cash today, miners are well aware that the lead times, and capital requirements, for large projects and the inherent volatility of their sector means they have to balance the demands of today’s shareholders against those of the next generation, in whose interests it is that they do continue to invest.

Woodside may not be a one-off – Jan du Plessis at Rio and Jac Nasser at BHP are acutely conscious of the need to improve shareholder returns and relationships – and asset sales or demergers of some assets could provide an opportunity to do so – but hard commodity producers aren’t in the same position as the LNG giant.