Material Matters: BHP Billiton, Gold, Bauxite And Aluminium

This story features BHP GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: BHP

-BHP can return and re-invest cash
-Buying opportunity may present in gold
-Chinese bauxite demand likely to lift
 

By Eva Brocklehurst

BHP Billiton's ((BHP)) large resource portfolio provides exposure to commodities such as oil and US natural gas that are less influenced by the industrial trends in China. Morgan Stanley finds this appealing, particularly given the volatility surrounding China's transition away from fixed asset investments. The broker expects BHP to announce exceptional capital returns to shareholders when it reports in August. The portfolio has sufficiently attractive resources and operating mines to be able to re-invest cash as well. This justifies the valuation premium, in the broker's view, with BHP trading at 12 times FY14 price/earnings compared with Rio Tinto's ((RIO)) 10.6 times.

Morgan Stanley thinks returning cash will a be a near-term consideration for companies and a driver of share prices. In the case of BHP, the company has not yet decided how much, and if the return will take place via share buy-backs or special dividends. The CEO, Andrew Mackenzie, has stated that capex will be limited to US$15bn per year in FY15 and beyond, including US$4bn in maintenance capex and exploration spending. The remainder should meet a hurdle of 20% unleveraged internal rate of return. Morgan Stanley calculates, taking out investment in the Jansen potash mine, Escondida copper mine, and US$4bn for US onshore gas, there is around US$4-5bn that needs to be re-invested at the minimum hurdle rate. The main investment is expected to take place in iron ore and copper.

UBS has shared some feed back from a bauxite and aluminium industry expert, regarding the Indonesian ban on unprocessed mineral exports and future of China's bauxite supply. The next catalyst will be the Indonesian election and, regardless of the outcome, the expert expects there will be some concessions to miners. There is also the possibility of a hike in the export tax rate to 30-50% from 20%. China has apparently built up a year's supply of bauxite in anticipation of the ban and once this is consumed will need to find a new source. Bauxite is not rare, but UBS observes development of new bauxite mines is a slow process because of constraints on approval and a high inducement price.

China is currently trialling Atlantic sources from Jamaica, Guinea and Guyana, as well as Pacific sources such as Fiji and India. UBS notes Rio Tinto is benefitting from the scaling back of the Gove refinery in Northern Territory, which allows for more bauxite exports. UBS also said the discussions revealed Alcoa does not believe Australian bauxite is desirable in China's refineries. UBS thinks this is at odds with what Alumina ((AWC)) has stated about the marketability of its bauxite. Alcoa apparently believes that, if the aluminium content can be beneficiated, it could be very marketable.

The discussants also looked at the port development potential for Alcoa's bauxite exports from Western Australia but the costs were ascertained as unattractive. The industry believes China will be better off sourcing bauxite domestically rather than purchasing it, but China will need to build new alumina refineries that can process to domestic bauxite specifications. Bauxite reserves in China are limited as most of northern China's deposits have been allocated to refineries. Current unallocated reserves are expected to last only 2-5 years. Grades are also expected to plummet.
 

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