A currency war isn’t the same thing as a shooting war, at least not at the beginning. But there are certainly casualties. In today’s Daily Reckoning, we take a look at the winners, losers, and the next stage of the great battle of all against all, in which the sides aren’t really what they appear.
Former Rio Tinto CEO Tom Albanese is a casualty. But don’t you worry about him. He’ll land on his feet and be just fine. The real losers from Rio’s strategic failure over the last few years are the shareholders. It will be interesting to see if the shareholders put pressure on Rio’s board, which is every bit to blame for the company’s performance as the CEO.
We’re not just trying to assess blame, though. That’s all too easy and all too common. Instead, we reckon Rio’s changing of the guard signals that the easy money – and probably the big money – from the commodity boom is over. Like the whole commodity sector, Rio was able to ride the boom in commodity prices and then export volumes to make easy money.
But record sales aren’t necessarily an indication that directors are doing a good job managing the company’s capital. Rio ran a 33% return on capital in 2011. It was just 16.7% in 2012, according to Goldman Sachs. The company wasn’t able to take shareholder money and generate consistently high rates of return.
To be fair, maybe that’s because there weren’t too many good places to invest the money. Rio wrote down $29 billion worth of acquisitions in the last five years. A big chunk of the write-offs came from the disastrous Alcan acquisition, which was mostly made to fend off BHP’s semi-hostile take-over overtures at the time.
If you just back it up, though, and look at it from an entrepreneurial perspective, it was a big gamble that base metals would be a growth sector anyway. Aluminium is the most energy-intensive of all the metals to produce. And any punt on base metals is a punt that Chinese demand will keep on keeping on for the next twenty years.
By contrast, BHP chose to diversify in oil and gas, rather than coal and aluminium. The jury is still out on BHP’s acquisitions. And BHP has already written down the value of $2.84 billion on its Petrohawk acquisition in the US shale sector. But in the big picture, energy seems like a better growth bet than base metals.
Rio shareholders must now be wondering if the best thing to do with all that money was to return it to shareholders as profit. After all, companies exist to generate income for their owners. If you can’t put excess capital to work generating an additional profit, then pay it out to the people who financed you in the first place.
That’s all back-seat driving now, of course. But the whole Albanese affair gives the company a chance to focus on developing its world class iron ore assets in the Pilbara. The margins on the iron ore business are great, owing to the quality of the ore. And it’s what Rio does best. The only trouble for resource bulls is that there might be a lot less growth now than there was five years ago.
Not that trouble is anywhere on the horizon today. One of the more interesting bits of data from China’s boring fourth quarter GDP figures last week is worth a closer look. Fixed-asset investment rose 20.6%, year over year, for a total of $5.81 trillion, according to China’s National Bureau of Statistics.
This is exactly the sort of ammunition that gives resource bulls’ hope and heart. And if you were building an argument that China’s boom could last longer, and benefit Australia even more in the coming years, you’d point out that investment in the central regions grew by 25.8%, investment in the West grew by 20.6%, while investment in the East grew 17.8%.
In broad strokes, this is the argument that China’s rising tide of prosperity is moving like a slow-motion tsunami from the coastal regions of the East, across the interior, to the poorer and more rural regions in the West. That’s not to say that what has happened in Shanghai and Beijing will be replicated over and over the further West you get. Then again, maybe that’s the central plan.
All that said, China’s annual expansion of 7.9% in 2012 was the slowest since 1999. Take your pick. It’s either the bottom of a trend, or part of a longer trend in which growth is much harder to generate. What’s more returns on investment – whether fixed asset investment that isn’t driven by the profit motive can work – are yet to be measured.
for The Daily Reckoning Australia