Olympic Dam: Pie In the Sky?

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By Greg Peel

A year ago, the world's largest global diversified resource company BHP Billiton ((BHP)) had announced plans to invest US$80bn in capital expenditure in the years ahead on tier one mining/drilling development projects and expansions. Underpinning this ambitious plan was a desire to ensure BHP's place as the world's most dominant commodity supplier into the future, with expectations that the Chinese growth story in particular was far from over.

While it may be the role of management to secure a company's success into the distance, shareholders were taken aback and disappointed by the substantial capex announcement. With Chinese demand having pushed commodity prices higher and turned BHP into a global cash-generating machine, shareholders were looking for a translation of this wealth into a return on their capital. BHP, in line with all miners, has never been a big dividend payer. But surely all that cash could provide for a special capital return or at least a share buyback? BHP's share price was yet to recover its previous peak in early 2008.

It wasn't to be. Instead, BHP elected to spend its cash over time on global mega-projects. These included the expansion of the company's Pilbara iron ore operations and of its copper operations in Chile. BHP has also since diversified into the world of fertilisers with a big investment in a Canadian potash resource, and has augmented its energy sector activities with significant acquisitions of US shale oil/gas assets. And then there is Olympic Dam, in South Australia.

“Without a doubt,” suggest the analysts at BA-Merrill Lynch, “Olympic Dam is an extraordinary asset”. Olympic Dam boasts the largest uranium deposit in the world as well as the fourth largest copper deposit. If that's not enough, it may also prove to be the world's largest gold deposit. Truly a remarkable patch of dirt, of which any global mining company must be very envious. To reinforce this point, BHP has been recently running around securing further tenements adjoining its existing plot, if for no other reason than to ensure no one else gets their hands on them.

Mining analysts have responded with little less than whistles of awe at the scale and potential of BHP's tier one development/expansion “mega-projects”. Such appreciation has led BHP to attract almost rusted on, value-based Buy ratings from stock brokers in the interim. Occasional Hold ratings have mostly been shorter-term reflective of a preference for BHP rival Rio Tinto ((RIO)). This is despite that which has shareholders wondering whether they are prepared to hold for years to see that value realised. By the end of FY11 – a year of substantial earnings growth for the company – consensus forward estimates for FY12-13 had BHP delivering little to no earnings growth. Cashflow was not an issue, it's just that earnings would be all sucked up into capex.

Moving forward into FY12, we find that things have since gone just a bit pear-shaped for the Big Australian, or “The Big Fella” as management prefers us to now nickname the company given its global footprint. Recession and ever present risk in Europe, a stumbling US economy and, perhaps most importantly, a clear slowdown in the Chinese economy have all conspired to send commodity prices lower. At the same time, on the other side of the ledger, costs for the resource sector have continued to rise exponentially. Either factor would have any miner reassessing the scale of its development pipeline. Both together have meant embarrassment for BHP as the company has been forced to write-down, delay and generally back off.

BHP shares are currently trading at a price equivalent to that achieved in April 2009. Shareholders who have held on over that period, comforted in the knowledge of almost consistent Buy ratings from stock brokers, have seen $30ps become $47ps and then $30ps again.

The good news is that BHP has now elected to provide shareholders with a progressive dividend policy – to grow dividends rather than treat them as a small extra on top of assumed capital appreciation. GFC-bitten investors are now seeking yield over growth at at time when growth seems ever more elusive.

The bad news is that the previously assumed value in BHP's mega-pipeline is seemingly waning as each month passes. The company may have to write down some US$2bn of the value of its aluminium assets in an oversupplied market. There is much speculation surrounding just what amount of the company's US$20bn investment in US shale will need to be written down. Not only have natural gas prices wallowed in the US, there have been questions raised as to whether BHP's due diligence on its US$4.75bn asset acquisition from Chesapeake Energy was up to scratch. At the end of this year, the company must decide to just what extent it will expand its Pilbara iron ore operations and infrastructure. 

Then there's Olympic Dam, again. It is assumed at least one of BHP's mega-projects will need to be put on ice for the time being. Will it be Canadian potash? Or will it be the world's largest uranium/gold/copper resource?

Last week mining analysts in London sat down for breakfast with BHP's Chief Executive Non-Ferrous, Andrew Mackenzie, and President Base Metals, Peter Beaven. BHP's mega-pipeline was a hot topic over bacon and eggs.

The company continues to showcase it's potential growth projects, but will strike a balance between short and long term returns. The company also seems committed to retaining ownership of its tier one jewels so is unlikely to ever sell down ownership stakes to raise capex funding. In Citi's view, “This will result in the continued staging and potential push-back of large scale projects”.

On the plus side, BHP remains very keen on copper. The copper market is expected to remain tight as grades decline globally and existing resources are exhausted, making copper far more promising a pursuit than aluminium, for example. Previously it appeared, Citi notes, that BHP's copper division had been left out in the company's massive capex allocation in favour of energy and iron ore. This now appears to be changing, with Escondida on track and guidance unchanged, Antamina all but complete, Pinto Valley expected to restart by year-end and Cannington (silver/lead/zinc) offering significant scope for increased mine life. The Merrill Lynch analysts suggest "brownfield growth is our favourite kind”.

Merrills also notes there are still more studies to complete before BHP commits its copper capex. Citi would like more confirmation the company's “build versus buy” intentions when it comes to weighing up greenfield/brownfield capex spend. The Citi analysts do note Mackenzie's suggestion that acquiring in the current market remains difficult. Merrills believes assets like Cannington and Pinto Valley are “non-core” and could thus be offloaded.

As for potash, Mackenzie suggested that while the company would likely continue to sink two shafts at the US$10bn Jansen project site, construction of some of the surface infrastructure may be delayed. This implies the "staging" of another mega-project.

What then of Olympic Dam? There was a lot of discussion at breakfast. On Merrill's “simple analysis”, the project struggles to generate net present value if some US$25-30bn of capex is assumed. Mackenzie acknowledged that the first phase of the project struggles more than any other BHP project. The value, Mackenzie highlighted, lies in long term optionality.

Which means we can probably kiss goodbye to the world's largest uranium deposit, fourth largest copper deposit and largest gold deposit, for now at least. Merrills sees a decision on the Olympic Dam expansion being pushed out “as far as is feasible”. This could mean 2018-19. That's the decision mind, then the work has to begin.

For those slightly more mature shareholders amongst us, it may be a case of expanded Olympic Dam (actual) production aspirations being left for one's children. In the meantime there's copper, and perhaps iron ore, and possibly shale gas, and maybe potash to dream about.

FNArena's Stock Analysis shows five Buy ratings or equivalent on BHP among the eight brokers in the database, and three Holds. The consensus 12-month share price target is $41.78, only 37% above today's price. The 52-week range on the share price is $30.50 (we're below that today as I check) to $43.78 (April). The all-time high is $48.70 (May 2008). 

Source: eSignal

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