–Poor BHP Billiton. The Big Australian just can’t get a date to the prom (or the year 12 formal). Today’s Australian Financial Review contains the jaw-dropping revelation that since Marius Kloppers took over as CEO in 2007, BHP has spent over $875 million on abandoned deals. That’s a lot of money to spend on dinner and a date without even getting a kiss goodnight.
–The three main failed amorous advances were the pass made at Rio Tinto, the indecent $350 million proposal made to Canada’s Potash (rejected by strict Canadian regulators/parents), and the proposed merger of BHP’s and Rio’s West Australian iron ore operations. Is Marius Kloppers a star crossed corporate lover or just a CEO with too much cash and not enough to buy?
–It’s a question BHP’s shareholders should probably take up with him. A billion dollars is a lot of money to spend for no result, even for a company that’s slated to generate about $40 billion pre-tax earnings over the next few years. The issue for investors is whether the management is being a good custodian of shareholder capital.
–We’re going to put the question to our valuation guru Greg Canavan. Greg’s been doing a survey of the Australian investment landscape from the perspective of someone who believes in both sound money and sound investment principles. We’re calling it the Sound Investments Series. You can sign up to get the next report (and view the previous two) by going here. The Series is free, for now.
–The first two instalments were on the big retailers and the big banks. The next one—due out this week—is on the big miners. Mining is a capital intensive, cyclical business. Mining companies (producers anyway) used to be valued quite conservatively. But nowadays some analysts are valuing mining companies like growth stocks, based on pretty optimistic earnings estimates (commodity prices that never fall because China grows at 9.3% for the next twenty years).
–Greg is probably not the sort of analyst who’s going to value BHP like a growth stock. But we haven’t seen the final report yet either, so you never know. In any event, BHP is a pretty good case study for how to determine what an acceptable rate of return is for shareholders. Are the managers generating regular and healthy returns on shareholder equity…or are they just coasting on higher commodity prices and regular growth in production volumes…without growing the resource base?
–The company has been growing its net operating cash flows by a compound annual growth rate of 21% since 2002. You can attribute that impressive performance to the rises in underlying commodity prices (iron ore, coal, and oil, where BHP is surprisingly one of Australia’s largest crude oil producers). But when you’re generating cash, it presents a problem. What are you going to do with it?
–Granted, having a lot of cash to throw around isn’t a bad problem, although it’s no guarantee you’ll get what you want either. Having a lot of cash is a good test for management. And based on BHP’s decision to buy back another $4.5 billion in stock yesterday, it’s a fair time to ask if BHP’s management is making the best use of its cash.
–Resource investors generally don’t want their money back in the form of a dividend, or increasing earnings per share based on a reduction in the number of shares on offer after a buy back. Mining companies (and oil companies, since BHP is one of those too) must constantly grow their resource base since they are constantly depleting it with production. That’s not to say you shouldn’t buy your own shares if you’re a CEO and you think they are good value based on what you know of your own company. But you don’t’ want to be spending more money on shares than you are developing new assets.
–Lately, BHP has taken to pursuing acquisitions to grow revenues and its asset portfolio. That doesn’t mean its organic growth is terrible. But it does mean the company may have trouble achieving higher rates of growth if it keeps getting shot down on acquisitions. This would presumably affect the valuation of the share.
–So what is the share really worth now? We’ll wait until we see Greg’s report and get back to you. In the meantime, this whole discussion is a good reminder that passive buy-and-hold investing in blue chip shares is not without its risks. This is especially true in Australia where the largest capitalised companies in the share market (and the most widely owned in retirement funds) are miners and bankers.
–It would be an interesting discussion if you set out to decide which business was riskier these days, a gold mine or a bank. But our point is that if you aren’t already doing it, it might be worth putting some thought into when and where these stocks make their cyclical highs and lows and when they are looking overbought or oversold.
–This, of course, is precisely what Murray is up to. Murray, if you don’t already know, runs the Slipstream Trader. His job there is to keep a technical eye on everything and let readers know, based on his theory of price action, when he sees decisive (or false breakouts) in a particular share. You can read more about how he’s trying to help you make ‘bonus gains’ from stocks you may already own.
–While we’re on the subject of the miners, by the way, why aren’t any of their CEOs telling the government to stick it where the sun don’t shine with respect to the Mineral Resources Rent Tax? It’s telling that in recent weeks two international organisations (the OECD and the IMF) have both come out in favour of the tax and its broader application at a higher rate.
–Typical. These organisations have the best interests of big government at heart. And that may be different than what’s best for Australia or Australia’s best businesses. It’s also worth noting, in a totally non-xenophobic way, that the government’s pre-election agreement was made with an Australian company run by a South African, a dual-listed Rio Tinto that has international interests, and a Swiss company.
–It’s clear what was in the deal for everyone who was at the table. But there were a lot of people that weren’t even invited to the table. Or perhaps they were, but as the main course rather than an equal partner in how to carve up Australia’s resource wealth.
–Trans-national organisations that serve the interests of the nation state are always encouraging higher taxes and more government intrusion into the economy. Because that’s worked so well. The government here will use the OECD and IMF statements as support in its campaign to subdue and intimidate the mining sector. They will love it because it encourages them to take what’s not theirs, which is something the government is especially good at.
–Where is this generations Lang Hancock? Isn’t there anyone in the Australian business community who is willing to tell the government that it’s nothing but a pack of plundering, meddling, no-nothing boobs who’ve probably never met a payroll or created real wealth in their life?
–We understand that in a small elite community, there are probably repercussions for speaking the truth about possibly vengeful public servants with “long memories.” But someone should be sticking up for the interests of free enterprise. When the State tries to paper over its over-spending ways by stealing away the profits from whatever business happens to be most profitable at the moment (yesterday it was the miners, today it’s the banks), it perpetuates wasteful spending and bad government.
–It’s also galling to be told by people who don’t really believe in free enterprise how to run your business, or that you owe it to them (and will be coerced) to run your business for the benefit of someone else (as if running your business to benefit your customers, employees, and shareholders isn’t enough).
–Worst of all, if you let the government believe it can tax you whenever and however it wants, it perpetuates the idea that a bunch of mealy-mouthed and power hungry bureaucrats from Canberra are in the best position to decide how much profit is too much and who should be punished and rewarded.
–Enough already. Tell these people to crawl back into their cave of non-understanding and quit doing real damage to one of Australia’s most successful and competitive industries. Australia’s sweet spot in the global economy allows the mining tax to be perceived as sensible when it’s anything but. It’s clumsy, stupid, blundering policy made by people who don’t understand mining but do understand theft.