BHP Billiton: Result 2012

Predictions that lower commodity prices would savage BHP Billiton’s full year results turned out to be unfounded. Lower prices did result in lower profits; underlying net profit was down 21% to US$17.1bn after excluding an embarrassing writedown of shale gas assets and other one-offs, but considering the fall in commodity prices, this was an excellent result. From earnings per share of US$3.26, down 18%, a fully franked dividend of US$1.12 (ex-date 03 Sep) was declared.

Despite falling 19%, net operating cashflow is still comically large at US$24.4bn. Our concern has not been with cash inflows, but with outflows; with capital expenditure of US$22bn there is little buffer from lower future prices. Just as well that this year’s colossal capital expenditure is unlikely to be repeated for a time. BHP announced it was canning some of its biggest development projects, including the expansion of Olympic Dam, construction of a new harbour in Port Hedland and pursuit of a potash business in Canada. Combined, these three projects alone would have cost more than US$30bn.

Abandoning expansions that it had previously unveiled with glee isn’t simply a response to shareholder criticism; it’s recognition of a new reality. Cashflows have fallen with commodity prices and there is little prospect of a quick recovery. Continuing to expand under such conditions would have required an injection of debt to fill gap between cash inflows and outflows. Management’s previous blind pursuit of growth threatened to take BHP to the edge of a precipice. With a more conservative outlook this year, BHP has elected to step back.

The iron ore division remains a standout. Return on assets (ROA) has fallen from 97% last year to 76%. Even under the threat of lower prices, this remains an excellent business. The same cannot be said for BHP Petroleum, where ROA has fell from 45% last year to 16% this year. The difference reflects the inclusion of shale gas assets on BHP’s balance sheet. So far, the returns from shale gas has been poor but this might change as BHP deploys more rigs to oil instead of gas. We'll be looking for an improvement next year.

The great surprise was how poor returns from some of BHP’s less celebrated divisions was. The aluminium and nickel business in particular, where ROA was negative and 3% respectively, are probably both contenders for sale. These divisions are a better reflection of how many miners are faring thoughout the industry.

With lower capital expenditures in future years, BHP may continue to accumulate free cash flow even as commodity prices fall. It’s now on our radar and a share price closer to $30 is likely to trigger an upgrade. The share price is up marginally since BHP: Hedge or hog from 20 Jun 12 (Hold – $32.85). For now, HOLD.