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Marius Kloppers, CEO BHP Billiton

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BHP Billiton looks for deals to grow

Allan Seccombe | Wed, 22 Jul 2009 21:30

[miningmx.com] -- THE rapid deterioration in global commodity prices has taught mining firms some difficult lessons, but it has also brought an opportunity that doesn’t come round often – a chance to buy rather than build projects.

BHP Billiton, the world’s largest mining firm, says it has overhauled the way it does business and is scouring the globe for opportunities in the commodities it sees benefiting from an economic recovery, particularly in China and other developing countries.

“We have to decide whether to build something new or to buy something, I think the equation is now more slanted towards buy than build,” says Marcus Randolph, the CEO of BHP’s ferrous and coal division.

“If you look at company valuations versus the cost of building things right now, it’s probably as favourable to acquire as to build,” he said.

Joint venture queried

BHP will spend $5.8bn to set up a 50/50 iron ore joint venture with Rio Tinto in the Pilbara region in Western Australia, which will save $10bn in costs and synergies.

Western Australia’s premier Colin Barnett is reported by the Financial Times as raising the concern the joint venture could enable the two companies to avoid A$1bn in stamp duties. The deal has to secure regulatory approval from the Western Australian government among others.

The iron ore joint venture lies at the heart of BHP’s bid for Rio. If it clears regulatory hurdles and is implemented in about a year’s time, it will create the world’s largest iron ore producer, much to the consternation of the Chinese, the leading steel producer.

BHP had made an offer worth around $148bn for its rival Rio Tinto, but it took the offer off the table in November 2008 at a time when the markets had plunged in the throes of a global economic meltdown and commodity prices had fallen hard from their highs.

We have the cash to expand when others may not

BHP is one of the few major mining groups unencumbered by debt and putting assets up for sale to bolster its balance sheet. It gives it a distinct advantage.

“What it means for us is that those assets that almost never become available, some of them are available now. They’re still expensive but we’re getting options that we wouldn’t have had otherwise,” Randolph says of the current commodity market.

The commodity choice is also critical. For products like copper or aluminium, the metal is delivered to London Metals Exchange warehouses for example, while iron ore, metallurgical coal and manganese are sold directly to customers.

“In some senses you have to think about if this has created an opportunity to take market share that you might not get otherwise. We have the cash to expand when others may not, Randolph says.

Whatever BHP does, it will have to move soon. There are budding signs of recovery in some metal prices and some economists are seeing the bottoming out and possibly a recovery from the global recession based on data from a wide range of countries.

Copper recovering

The price for LME copper on a three-month contract pushed to seven-month highs above $5,000/ton in early June as surveys of purchasing managers in China and Europe showed growth for the third month running in May.

The higher prices appear to be fuelled by speculators betting on an economic recovery rather than actual consumption, says Robin Bhar, an analyst at Calyon.

The turnaround in metal prices – but not iron ore – has driven share prices up. Rio shares, for example, have doubled so far this year, leading a charge up of mining companies’ valuations.

“Time is running out for BHP to put its pristine balance sheet and premium equity rating to good use,” Michael Rawlinson, a mining analyst at Liberum Capital, is quoted by TimesOnline as saying.

BHP’s highly regarded CEO Marius Kloppers urged caution when talking about a quick turnaround in the global economy, pointing out commodity prices at the time of writing were still 50% below their peaks.

The record high imports of copper and iron ore by China in the early part of 2009 should be seen as a rebuilding of stockpiles tied to the $587bn stimulus package there rather than underlying demand, he said.

It will take another six months for the global demand picture to begin clearing, he said.

“We have some residual concern in the very short term that there may have been some overbuying in anticipation of the stimulus package, which may have led to some stock-build ahead of real demand,” Kloppers said.

Time is running out for BHP to put its pristine balance sheet and premium equity rating to good use

“Importantly, in the medium term we don’t expect a sharp rebound in overall economic activity; in fact, we probably believe that economic recovery will be both slow and protracted,” he said.

The 30 member countries of the Organisation for Economic Cooperation and Development (OECD) will begin restocking commodities after they have run down inventories, but it’s not entirely clear when this will start.

“We do see stabilisation in the next six months as the OECD finds its base level and re-stocking commences, and as China’s re-stocking exercise evens out,” Kloppers said.

Poised for recovery

BHP is positioning itself for a recovery, which is likely to start in China and has a three-prong strategy to prepare itself.

The first element is to “find and capture” opportunities that these unusual times have made available, which is closely linked to the second element of how best to apply its cash and trade-off options in the buy or build spectrums.

Lastly, BHP is switching its production focus away from the volume-driven game of the past five or six years, with its attendant high costs.

“Prices have come down, so the focus has shifted from volume, pretty much at whatever cost, to stepping back to say how do we run these operations as efficiently as possible,” Randolph says.

BHP sees the global economy staging a two-speed recovery, with the United States and European economies lagging that of China.

The company doesn’t see indications of recovering demand in the industrial and manufacturing sectors that would consume the products BHP supplies.

Demand for specialist, high-tech materials like titanium and light metal alloys is still weak, while raw materials that are feeding into growth in the developing world remain in demand, which will help inform BHP’s decisions about what to invest in.

China, for example, is the world’s single largest steel maker and BHP reckons the country is not far off record steel production. While the Western markets are important because of their size, they are not seen as growth nodes.

“Under no scenario would you expect to see substantial increases in steel production in the US and Europe relative to where they were a year or two ago. In your best case scenario they get back to where they were which is sort of where they were 10 years ago,” Randolph says.

“So for us as a company, what happens in China and the developing world is absolutely critical,” Randolph says.

BHP is the world’s largest supplier of seaborne metallurgical coal, the largest source of manganese and the third-biggest source of iron ore.

“In a world where you would expect China to recover first, and China is intensively focused on the utilisation of steel, we’re in a fantastic spot for being a major beneficiary of a recovery,” he says.

China recovery

The Chinese economic recovery will not only be driven by the stimulus package, but a loosening of credit, which is expected to boost construction by private enterprise. Construction absorbs about half of China’s steel output.

Data from the China Iron and Steel Association showed daily crude steel output at 1,478 million tonnes in mid-May, the highest level since February, Reuters reported. An extrapolation of the data would indicate China is on course to produce 539.5 million tonnes of steel this year, which is 8% higher than in 2008.

The government, however, has said it wants to hold steel production down at 460 million tonnes.

Another increasingly important customer for BHP is India, which is the biggest growth area for the company’s metallurgical coal sales. BHP’s commodity sales to India in 2008 exceeded those the company made to China in 2002.

If India addresses its infrastructure like China is doing, it’s going to import large quantities of commodities.

“They’re behind (China), but they’re not that far behind,” Randolph says.