BHP Billiton Limited (ADR) (NYSE:BHP) is working through a broad downturn in the mining industry. But management wants you to know that things are going better than you might think, even though there are big changes on tap for one of the world's largest miners. Let's take a look at what BHP Billiton's leadership had to say about the company's interim results.
We are survivors
One of the more important things about the company's six month earnings update is that BHP is still making money. Although the roughly $0.80 a share of earnings was down nearly 50% year over year in the first half of the company's fiscal year, it shows that BHP is a survivor. That's no small feat, either, since virtually every commodity in which the company is involved, including once-strong oil, is in the doldrums.
CEO Andrew Mackenzie summed up well why this is so important: "Cycles will remain an enduring feature of our industry. So our strategy, the quality of our portfolio and the strength of our balance sheet will make sure that we're also perfectly positioned to capitalize on the expected price recovery for some of our key commodities." In essence, a miner needs to be prepared to handle downdrafts like this one so it can benefit from the eventual up cycles. BHP is proving right now that it knows how to survive the downside.
Adjusting to the times
Part of surviving the bad periods is being ready for them. According to Mackenzie, "[W]e started to prepare for a sustained period of lower prices almost three years ago by increasing our focus on efficiency and lowering our investment." The company has been reducing the cost of its mines and pulling back on big projects.
Some noteworthy and recent examples of BHP's success in these efforts include cash cost reductions of nearly 30% at the company's Western Australia Iron Ore business, a 15% drop at Queensland Coal, and an 8% reduction at the company's onshore U.S. oil operations. Moreover, the company's capital and exploration budget dropped by nearly 25% year over year in the first half.
That said, BHP isn't done yet. It hopes to keep controlling the costs it can, with expected reductions in capital spending next year and a continued focus on reducing operating expenses. However, it's important to remember something that Mackenzie pointed out -- future gains will be harder to achieve.
With such a strong focus on cutting costs and trimming capital budgets, you might expect the company to be pulling back on the production front. But that wouldn't be the case because its overall production was up 9% year over year in the period. CFO Peter Beaven highlighted what's going on under the numbers...
In iron ore, the company's most important segment, "Western Australia Iron Ore achieved another half yearly production record." In the oil business, the company had "record production." Although total copper production fell 2%, "Lower [ore] grades ... were offset by improvements in throughput." And metallurgical coal production was up some 20%.
This isn't a company that's pulling in its horns. BHP is actually getting stronger during this downturn by focusing on its best projects. And that means it will be prepared for the upturn when it comes.
We are moving forward with the spin off
That said, CEO Mackenzie was right in highlighting that future cost savings will be harder to come by. At this point, the low hanging fruit is gone. That's why he believes "structural change will be a catalyst for further progress."
That's going to take the form of spinning off assets that have less of an impact on the top and bottom lines. The new company, to be called South32, will contain BHP's aluminium, thermal coal, manganese, nickel, and silver assets. That will leave BHP with iron ore, copper, oil, met coal, and potash.
The goal is to "cut complexity and its associated costs in a single step with no loss of the benefits of scale and diversity." And since the assets that are going to be separated out are relatively small for the company (though material players in their respective industries), this appears to be a good option. But because this is being structured as a spin off, investors can make the call on whether or not they want to own South32 or not. Essentially, you can still own all of the assets now inside BHP if you want, just don't sell your South32 shares.
We won't be cutting the dividend
With the spin off, however, came a big question: the dividend. The CEO put that issue to rest, "So we do not plan to rebase our progressive dividend downwards should the demerger be approved, implying a higher payout ratio and any dividends from South32 will represent additional cash returns." BHP will pay the same dividend after the spin off as it did before, with plans to keep hiking it every year. That's good news for income investors.
And, while Mackenzie can't make any guarantees, it sounds like South32 plans to pay a dividend, too. If that happens, investors will actually be getting a dividend hike because of the spin off. All of that said, Mackenzie did point out an issue to keep an eye on when he said that BHP's payout ratio will go up.
Although BHP has been able to survive this downturn while still rewarding investors with annual dividend increases, paying out too much cash flow to investors via dividends could become an issue if commodity markets linger at the lows for an extended period. It's not something to worry about today, but you'll want to keep it in the back of your mind.
Solid showing, solid miner
Although these are five important takeaways from BHP Billiton's half year conference call, perhaps the biggest one, which encompasses all of them, is that BHP is doing fine in a tough market. If you are looking for a diversified way to invest in the mining industry, BHP should definitely be on your short list.