BHP should resist calls for growth

BHP Billiton (ASX:BHP) announced better than expected first half earnings this morning, despite prices of its two most lucrative commodities – iron ore and oil – collapsing during the period. Impressively, as a result of continued cost cuts and productivity improvements, net debt was steady while the interim dividend increased by 5% to US$0.62 per share.

Echoing Alan Kohler's call in today's Business Spectator for Australian companies to stop increasing dividends, analysts are encouraging BHP to utilise the commodities cycle downturn to pursue growth rather than returning capital to shareholders.

I disagree.

As colleague Gaurav Sodhi has noted, over the past 25 years – a time that covers a variety of manias, panics and crashes – BHP has not made a single operating loss. When incurred, losses have come from errors in capital allocation rather than as a consequence of low prices.

BHP's US$3bn writedown of some of its US shale assets is one example. Some would argue another is its merger with Billiton, given its upcoming spinoff South32 is mostly comprised of Billiton assets.

Its great rival Rio Tinto (ASX:RIO) isn't immune, of course, having subsequently written off most of its US$38bn purchase of Alcan.

The problem with management having excess funds at its disposal is that it encourages management to pursue acquisitions or growth for their own sake – what Warren Buffett calls the 'institutional imperative'.

Management benefits by presiding over a bigger empire and enjoying the higher salaries, bonuses and options that this usually entails. However, in the end, shareholders often lose.

If BHP does have the opportunity to purchase a quality asset at a reasonable cost (such as its Resolution Copper joint venture with Rio Tinto), then I would encourage it to do so. Yet such opportunities are rare and, given BHP's size, need to be massive to significantly impact its earnings.

So I hope BHP's management keeps concentrating on making the company more efficient while returning excess cash to shareholders. By deliberately reducing the amount of money it has to play with, management has fewer chances to reduce shareholder wealth.