Is this as good as it gets for big mining?

February 16, 2011

By John Foley
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

HONG KONG — Big mining never had it so good. BHP Billiton and Rio Tinto, basking in high commodity prices, have topped off record earnings with a plan to hand back a combined $15 billion to investors via shares buybacks. The two
Anglo-Australian miners are also stepping up capital expenditure dramatically — BHP spending $80 billion over five years. Big M&A is off the cards. Read between the lines, and the miners might just be getting ready for the turn.

Booming commodities — iron especially — have put a rocket behind miners’ earnings. Rio and BHP have both tripled iron ore operating profits since 2007. Accelerating Chinese urbanisation is the root cause. But miners have benefited from better negotiating terms, including the death of annual pricing contracts. Rising wages have also made many of China’s own mines uneconomical, doubling their cost of production over three years, according to one mining executive.

The financial world has played a role too. Copper prices are close to a record $10,000 a tonne, pumped up by real demand, but also by investors’ desire for an inflation hedge. Oil, which makes up a fifth of BHP’s operating profit, is comfortably above $100 a barrel for similar reasons. All of this has left the miners raking it in without breaking a sweat. Price increases alone added all of the growth in BHP’s earnings in the second half, and Rio’s in the full year.

But growth won’t continue at this pace, and animal spirits are abating. Even though the miners are now virtually debt free, big deals seem to be off the agenda. Three years ago, when prices were again high, Rio had just spent $38 billion acquiring aluminium miner Alcan, and BHP had proposed a merger with Rio. Granted, the wish-list nowadays is probably short. But when shrewd traders like BHP boss Marius Kloppers aren’t buying, it’s tempting to believe the assets are overvalued.

In turn, that may explain the focus on organic expansion and the lavish amounts of capital being ploughed into future
production. That is financially sound — BHP can get a 40 percent post-tax return on capital by investing in its own
business. But the faster they dig, the more the miners ensure that the supply of hot commodities will eventually rise to meet demand.

When it does, the resulting return to normality is unlikely to be calm and orderly. Investors, who value BHP at a rather unexciting 12 times this year’s estimated earnings, may be on the right track: for the mega-miners, this might be as good as it gets.

Post Your Comment

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/