BHP On Efficiency Drive

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– BHP sticking to plans underway
– Increasing profits with efficiencies
– Inner Harbour one target
– Qld coal another

 

By Greg Peel

It was February last year when the world's biggest diversified mining and energy company, BHP Billiton ((BHP)), was flying high and looking to an even rosier future. What to do with all the cashflow from selling iron ore, coal, copper and oil, among other things? Spend it! BHP CEO Marius Kloppers outlined some US$80bn in potential capital expenditure. World weary shareholders, hoping for some payback for their patience through capital returns or increased dividends, were none too amused. Capex would drain earnings growth forecasts.

Yet as Kloppers titled at windmills, 2012 brought with it a distressed European economy, a tepid US economy, and, most importantly, a slowing Chinese economy. Costs continued to rise as commodity prices drifted lower. Eventually, it became clear that planned grandiose expansion projects would not stack up on a cost/benefit basis in an uncertain world. One by one, BHP reined in its capex schedule, pulling out of a large coal mine project in Queensland, shelving potash expansion plans in Canada and giving up on the Olympic Dam uranium expansion in South Australia. Also on the hatchet list were plans to develop an Outer Harbour facility at Port Hedland in Western Australia to provide for iron ore to be loaded onto the twenty-first century's new, leviathan dry bulk carriers and to circumvent the Inner Harbour bottlenecks affected by crowding, outdated infrastructure and access rationing among BHP and its iron ore rivals, including Fortescue Metals ((FMG)). 

Shelving of the Outer Harbour project would have possibly stung the most, but the costs involved were too significant in a lower pricing environment for seaborne iron ore. In wielding the hatchet, Kloppers drew a line under the wish-list projects and vowed development of projects already underway or approved would continue, which included iron ore production expansion in the Pilbara.

The months have ticked by since BHP's change of focus and still commodity prices are lower, including a good scare for iron ore pricing. Yet costs remain stubborn. When a new asset is beyond reach for now, the fallback position is to squeeze as much value out of the asset you can. This is BHP's new approach, as outlined yesterday in an investor briefing by BHP's head of Ferrous & Coal, as the sub-heads of Iron Ore and Coking Coal rode shotgun. 

BHP will still strive to deliver on the major growth projects already underway, but it will then look to “de-bottleneck” existing assets before again giving consideration to new large projects. It's all about reducing costs and increasing profits through efficiencies and productivity gains rather than growth for growth's sake.

Brilliant stuff.

First we start with the clogged and overworked Inner Harbour facility at Port Hedland, at which new infrastructure and loading facilities sit alongside older and outmoded loaders, conveyors, stock yards and rail yards. With a bit of astute spending, BHP can increase direct ship-loading capacity from around 43% now to over 60% with a new rail marshalling yard at Mooka and better scheduling, and the addition of longer term stockpiling capacity at Boordarie. The completion of a fifth car dumper later this year will complement two new berths at Nelson Point, taking port capacity towards 300mtpa.

To take full advantage, BHP will also look towards snaffling up allocations of other producers on the use-it-or-lose-it rule, which analysts note mean Hancock's Roy Hill and Atlas Iron ((AGO)) some time between 2016 and 2018. BHP would pick up 70% of unused capacity, and Fortescue 30%.

At the other end of the line, low cost expansion of the Jimblebar mine will take net iron ore production to 250mtpa in FY14, 220mtpa in FY15, and 236mtpa in FY16. The wish-list target would be 300mtpa by FY18, at which point, and only at which point, Inner Harbour capacity would be exhausted and the Outer Harbour plans would have to be dusted off. BHP already has approval for two more future berths (to 10 in total), Citi notes, which could take the Inner Harbour above 300mpta anyway.

Meanwhile, on the other side of the continent, BHP admits that the coking coal market is a tough one at present. We tend to forget BHP is the biggest player in this market, yet not even the head of the division can see any clarity ahead. However were things to improve, BHP has the capacity to increase production at Caval Ridge to 8mtpa from 5.5mtpa, with 10mpta worth of infrastructure already being installed, by re-starting the Peak Downs project, recently cancelled.

Thereafter, it's all about those efficiencies again, in an attempt to lower costs and increase profitability. Some benefits will come naturally, as costs subside now the last of last year's floods have dried away, and as costly union disputes have now been settled. There are also savings to be had by the company hauling more of its own coal in Queensland rather than paying a contractor for the privilege. Unlucky, QR National ((QRN)).

Thereafter it's all about latent coal production capacity standing ready to take advantage of any market improvement, rather than thinking about even more large-scale growth projects at this juncture.

BHP is no longer taking the quixotic approach and instead is looking to squeeze the most out of what it's already got with efficiency drives and productivity. As Citi puts it, existing assets will be “sweated harder”. We've already heard of worker numbers being reduced – a ludicrous thought only a year ago. Next they'll only be serving domestic champagne in the board room. Shareholders have been thrown one bone with an increase to dividends post the suspension of high-cost capex allocations, and will be hoping for more if commodity prices can at least stabilise.

Deutsche Bank has lifted its earnings forecasts out to time by 1-3% as a result of the briefing, and retains a Buy rating among those FNArena database brokers providing an opinion on the new, leaner, meaner BHP to date. Citi also retains Buy, while BA Merrill Lynch believes the Big Australian is already well priced and is happy with Neutral.

Merrills joins JP Morgan and Credit Suisse with Hold or equivalent ratings, while Buys round out the eight database ratings. Consensus has a $38.45 target price for BHP, around 12% above the current trading price.

 

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