In the current environment, the big miners are almost a contrarian investment. The super-cycle that drove massive expansion of the mining industry has come to an end as demand in China slows.
But a deft response from the FTSE 100’s big three miners has given the shares a second wind. BHP (LSE: BLT) (NYSE: BBL.US), Rio Tinto and Anglo American have all installed new CEOs, cut back on capital expenditure and exploration costs, sold peripheral assets, taken an axe to operating costs and promised to increase dividends. That puts a second dimension to the investment case.
Cycles
It’s true that now is a contrarian, counter-cyclical time to invest in the sector, in the expectation that the supply/demand equation will eventually swing back in favour of the miners. The current trend is certainly adverse. The price of iron ore — a major part of BHP’s business — is down around 30% from its peak, and down 7% so far this year. Further weakness is forecast to last at least until 2017, with supply expected to exceed demand this year.
But the miners’ response has boosted profitability, and that has helped hold up the share price. So the second strand of the investment case is a call on the ability of management to squeeze additional shareholder value out of existing assets.
Success
BHP’s results for the last six months of 2013 show its success. Underlying profit rose 15% to $12bn. The company reckons that $5bn of annualised savings are embedded into the cost base.
Operating cash flow rose 65% to $12bn, effectively converting all the profit into cash, whilst $3bn cut in capex and exploration spend and $2bn of asset sales boosted free cash flow by $8bn. The interim dividend was increased by 3.5%.
Safety
BHP is a relatively safe play on the mining sector. First, it’s diversified. Though iron ore currently provides half of operating profits, copper and petroleum are both significant contributors. It also has substantial operations in coal, aluminium, manganese, nickel and potash. Secondly, its mines are mostly in developed countries, especially Australia — convenient for Asian markets — and North America. It has large, low-cost operations so it can weather downturns well. And it has a strong balance sheet, with moderate gearing.
With the miners’ new-found focus on shareholders returns, BHP’s yield of 3.8% is a tad above the average for the FTSE 100. But that’s during a cyclical downturn for the sector, so if it maintains its financial discipline in the future it should be a reliable dividend generator.