BHP: Result 2013

Only in the odd world of resources could a business report a 31% decline in net profit and still claim success. So it was with BHP Billiton, which reported net profit of US$11.8bn for the year to 30 June.

Higher coal and iron ore output and lower costs could not compensate for lower commodity prices, which stripped US$9bn from the operating profit. Earnings per share fell 31% to US$2.22 and a US$0.59 final dividend (fully franked, ex date 2 Sep) was declared, up 4%, making a total of US$1.16 for the year, also up 4%.

That dividends rose in a year where profits declined enormously is telling. BHP has confirmed it will cut capital expenditure from US$19bn last year to US$17bn this year. Next year, management forecasts capital expenditure of US$13bn. That’s just as well: with operating cash flow of $18.2bn, down 25%, there isn’t enough cash to sustain both current dividends and capital expenditure. In effect, spending on growth is being replaced by dividends. Shareholders are unlikely to complain. 

Production for the year was outstanding in iron ore and metallurgical coal, where output soared 11% and 9% respectively. Iron ore production of 188m tonnes last year is expected to rise to 260m tonnes per annum in the years ahead as the company completes its Pilbara efficiency drive and transport expansions.

Potash plans

We remain concerned about persistently low coal prices, so it’s pleasing that BHP is focusing on cutting costs from its coal business. It is also, however, seeking to increase production, especially of metallurgical coal. That might work – BHP commands the best metallurgical coal assets in the world – but increasing output under current conditions is questionable.

Controversially, the company will spend US$2.6bn on the Jansen potash project in Canada between now and 2016. The full development of Jansen will cost another US$10bn but it will ultimately produce about 10% of global output, entrenching BHP as a low-cost producer.

The market reacted to the move with disapproval. There were expectations that, with the collapse of the Belarus potash cartel, BHP would abandon its potash plans – but it has merely delayed them. It’s too early to determine the wisdom of this. Jansen is one of the world’s best potash deposits and could potentially be highly profitable, but it is also one of the most complex capital-intensive projects in a business full of complex capital-intensive projects.

Good oil?

Which brings us to the petroleum division, where BHP holds about US$40bn of assets. It is here that BHP is spending most of its capital expenditure – US$7.7bn most recently – to lift production to 250m barrels of oil equivalent annually from 2014. That’s the equivalent of 70% of Australia’s total annual oil consumption, or the equivalent of three Woodside Petroleums.

That enhanced output comes at a cost: BHP’s return on assets is falling. In 2008, before the entry into US shale, the division reported return on assets (ROA) of 46%. This year, it reported ROA of just 12% because shale is far more capital intensive than conventional oil.  We’ll be watching returns from petroleum closely for signs of improvement.

We were a whisker away from upgrading the stock in BHP on the edge on 17 Apr 13 (Hold - $32.14). Although the share price has increased 11% since then, there’s a good chance we’ll get a shot at upgrading The Big Fella at prices around $30. Until then, HOLD.