Belt Tightening is All the Rage in this Sector

Companies across the market are taking drastic steps to slim down in order to boost their growth prospects.

Reuben Gregg Brewer
Reuben Gregg Brewer
Apr 17, 2014 at 12:15PM
Energy, Materials, and Utilities

Finding a way to grow a business gets increasingly difficult the larger it becomes. The law of large numbers ensures this almost ironic fact. This is why companies like Encana (NYSE:ECA) and BHP Billiton (NYSE:BHP) have already made moves, or are at least considering actions, to slim down.

A giant miner
BHP Billiton has shifted gears from growth and expansion to focusing around improving its iron ore, coal, copper, and oil units. The international mining giant, however, is a much larger company than that, so this decision leaves it with a number of businesses that just don't fit anymore. According to the company, "We continue to actively study the next phase of simplification, including structural options..." Essentially, BHP is looking at the possibility of a spin-off.

Such a move makes complete sense, since the four focus areas made up about 88% of revenues in the first half of BHP's fiscal year that ends in June. The remainder stems from business units that only accounted for about 1% of BHP's profits from operations. You can see where getting out from under these units would lead to better overall results.

(Source: Lyn Lomasi, via Wikimedia Commons)

However, spin-offs aren't the only way to slim down. For example, Leggett & Platt (NYSE:LEG) has been shedding businesses to boost its growth profile. It's set fairly stringent targets for its diverse collection of assets. Leggett & Platt will continue to invest in a business with a return on gross investment (ROGI) of 12% or higher. Units with ROGI of 9% to 12% can stick around, but are looked at as cash cows. Anything else either needs to be fixed or is jettisoned. Leggett & Platt's management is direct; it wants to, "Significantly improve or exit low‐margin businesses."

An example of this is the company's 2013 write-down of its commercial vehicle products (CVP) group. According to Leggett & Platt, it has been, "...considering strategic alternatives for its CVP unit, including possible divestiture..." Leggett's $0.31 a share write-down is part of the preparation process. Although that non-cash expense left earnings over 20% lower for the year, it shows that Leggett is serious about pruning its portfolio for the long-term benefit of the company.

BHP, in fact, has used this tactic, too, selling its uranium assets to effectively exit that business . So there's no reason to think that a BHP spin-off is the only way to go.

Big-buck asset sales
There's plenty of value to be created with a sale; just ask Encana. The company recently agreed to sell natural gas fields in Wyoming for $1.8 billion. CEO Doug Suttles described the transaction's value in this way: "With the divestment of Jonah, we are unlocking value from a mature, high-quality asset and allowing our teams to focus on our five core growth areas and continue with execution of our new strategy."

In other words, Encana is slimming down so it can refocus on higher growth assets—and a $1.8 billion cash infusion can only help. Leggett & Platt and BHP aren't in exactly that position, since the assets they are looking to sell are laggards and will likely be harder to sell. Still, for BHP anyway, it shows that large asset sales aren't out of the question. Though, one just might require a Leggett-like write down.

LEG Chart

LEG data by YCharts

More than one way to skin a cat
In the end, there's more than one way to slim down and boost growth. What's worth watching is the trend for companies to take a more active role in managing their business portfolios. Keep an eye on BHP to see how it plans to unlock value for you. Encana and Leggett & Platt, meanwhile, are worth watching because they are well along the way toward cleaning house.