By Clyde Russell
LAUNCESTON, Australia Dec 11 It's taken some
time but there are signs that the cost-cutting efforts by major
commodity producers such as BHP Billiton and Rio Tinto are
starting to convince investors.
"My principle aim is to create value and free cash flow,"
Andrew Mackenzie, the chief executive of BHP ,
said at an investor briefing on Dec. 10.
To this end he confirmed that capital expenditure at the
world's largest mining company has been too high in recent
years, with the $23.3 billion spent last year poised to shrink
by 25 percent in the 2013 fiscal year, and again in subsequent
The presentation slides anticipate capital expenditure for
major projects being a quarter of the 2013 level by 2016.
Rio Tinto , the world's second-biggest miner,
is also slashing spending, announcing plans to halve capital
expenditure and slash debt.
Rio Tinto said on Dec. 3 that it will cut spending to $11
billion in 2014 from just under $14 billion this year, and sees
capital spending at $8 billion in 2015, which would be less than
half what it was in 2012.
The cuts are more than that of its bigger iron ore rival
Vale of Brazil, which unveiled on Dec. 2 a 9 percent
capital spending reduction to $14.8 billion for 2014.
While it's too simplistic to say the savings in capital
expenditure will flow directly to net income, the aim of the
chief executives of the mining giants is definitely to improve
profits, and thereby share prices.
Assuming BHP does manage to cut capital expenditure to
somewhere closer to $6 billion by 2016, it could potentially
double the $17.87 billion in net income before taxes recorded
for the 2013 fiscal year.
Of course, this assumes that all other parameters, such as
operating expenses and commodity prices, remain constant, which
they likely won't.
But it does serve to illustrate just how big an impact the
capital expenditure savings could have on profits, especially if
BHP can do what Mackenzie promises, namely continue to deliver
output growth in addition to the cost savings.
Mackenzie said he isn't focused on boosting volumes, but
nonetheless expects output growth of 16 percent in 2013-14.
The aim for BHP and its competitors is to concentrate on the
high volume, high margin parts of their businesses, such as iron
INVESTORS START BELIEVING
It also appears equity investors are starting to buy into
the story, with BHP and Rio Tinto shares showing some
BHP's Australian-listed shares are down 0.8 percent from the
start of the year to the A$36.82 close on Dec. 10. But they have
gained 19.5 percent since the 2013 closing low of A$30.81 on
The S&P GSCI Index, which is a good proxy for BHP
given it contains energy and about a third of BHP's revenues
comes from petroleum, has lost 2.5 percent this year, and has
only gained 4.8 percent since its year-low on April 17.
Rio Tinto's shares closed at A$66.17 on Dec. 10, up 0.2
percent so far this year. Since their closing low on June 26,
they have gained 31.7 percent.
Given that Rio makes the bulk of its profits from iron ore,
a comparison with the Asian spot price is
Iron ore has lost 3.8 percent since the start of the year to
the close at $139.40 a tonne on Dec. 10, and it has gained 26.2
percent since the year-low of $110.40 on May 31.
What these numbers show is that since the lows for both
commodity and share prices, the Anglo-Australian giants have
done better than the commodities they produce.
However, both have a long way to go before scaling the
heights reached in 2011, when BHP peaked at A$49.55 in April and
Rio Tinto reached A$88.68 in February.
In the year to June 2011, BHP's net income before taxes was
$31.25 billion, about 75 percent more the amount achieved in the
year to June 2013.
However, the cost-cutting programme may be enough to return
profits close to the 2011 levels even if commodity prices remain
constrained by the gradual slowing of demand growth in China,
the world's biggest buyer.
Disclosure: At the time of publication Clyde Russell owned
shares in BHP Billiton and Rio Tinto as an investor in a fund.
He may also own other shares mentioned as an investor in a fund.