Sitting in an office in Vienna, mainly focused on industrial stocks from anywhere in the world but Australia, it’s easy for me to forget just how stunning the resources reversal has been. The share price chart of any major commodities producer is a stark reminder.
The BHP Billiton share price, for example, is down 70% from the peak. And that’s in Australian dollars, the share price fall would have been more acute if not for the massive fall in the Australian dollar over the past few years.
BHP is far from an exception. Look at any of the majors – Rio Tinto, Vale, Anglo American, Glencore – they’re all down 70% plus from their peaks (2007/08 or 2011 mostly). Most of them are trading at roughly 2004 share prices. It’s like China never happened.
But China did happen.
BHP, for example, has taken net borrowings from around US$5bn in 2004 to US$25bn today. That’s US$20bn all gone into new holes in the ground.
Its balance sheet shows that over that 12 year period, it has retained about US$50bn in earnings (ie profits not paid out as dividends). That’s another AUD$71bn gone into holes in the ground. Given the anaemic capital gains since 2004/05, that US$50bn of retained earnings might as well have been piled up and set on fire, that’s how much value it’s added.
Production volumes are up massively. Revenues have doubled, despite the massive pullback since 2011. By almost any measure, BHP is a bigger company than it was in 2004.
China clearly happened.
But in terms of shareholder wealth, the one that matters, it’s all been for nought, or close enough. Chinese demand didn’t create untold wealth (in the long run), but rather induced investment by the majors to the point of malinvestment. It’s a cycle that has repeated endlessly over the eons.
That’s why the major task for successful investors is to make the distinction between high quality businesses—those with pricing power and a moat—from run of the mill commodity price-takers. In the short term, they can be easy to confuse. But long term, only the high quality businesses can turn an economic tailwind into outstanding shareholder returns.
Australian investors forgot which type of business BHP was, and bid it up to unreasonable prices. They won’t forget that lesson soon, but they will again one day. For future reference, there’s a very obvious hint about the quality of the business in the name of the sector. They don’t call them commodities for nothing.
9 thoughts on “BHP Billiton: Hole in the ground”
Interesting post. Would have carried a great deal more weight if posted at the height of the boom though.
Cheers Hamish. I hope long term readers got the message. Both Steve and I have spent a lot of words warning about China and the resources boom over the past 5-6 years, at both Forager and, in my case, Intelligent Investor prior. I’ve linked just a few below (subscription may be required to access some) from 2010-11, back at the height of the bubble. We’ve been concerned about malinvestment for a long time. Consider this recent blog post as concluding remarks, rather than the first chapter.
This is perhaps a little harsh on the underlying business. It is possible to have a good business in a commodity industry when that business is the (or one of the) low cost producers as BHP is in numerous markets. The issue here appears to relate primarily to managements use of capital over the years.
I think that’s fair criticism JK. Judgement on BHP’s investment program should be made over the whole cycle rather than towards the bottom of it. But I just found it fascinating they’ve been able to reinvest US$50bn over 12 years for almost no capital gain per share. It would never happen to a business with pricing power. Cheers
Annd, these fools flogged off South32, so that its not even so diversified.
For a commodities business (ie one thats horribly competetive and full of price takers), a little diversification means that there might be a chance of the different commodities being high while others are low, and evening out some of the lumps.
Always thought miners should work when prices are good and close when they aren’t so good, because as you note they are essentially holes in the earth.
The capital items are pretty tough and corrosion shouldn’t be too bad over a decade.
Did buy BHP in 1990s when there was some crisis for $5 and sold a couple of years later for $8.
So it feels similar, and with inflation $5 probably equals $20 now.
But agree a lot of energy, resources and value lost.
Shareholders could have fared better with do nothing managers. The soccer goalkeeper who stays central at the penalty kick (does nothing) is thinking ahead.
See any value now?
That’s the right question Craig. We’d own BHP, and just about any stock, at the right price, and it’s certainly closer than it was a few years ago. We think South32 is more compellingly cheap at the moment, but we’ll keep an eye on BHP and other majors globally.
This is precisely why I believe that to make a truly long term investment, one needs to evaluate not only the value of the underlying business that Mr Market is selling, but also the capacity and skill of management as capital allocators.
With very large companies like the miners mentioned in this article, capital allocation decisions, whether directly (where the board votes on large allocations of capital themselves) or indirectly (where a board appoints a CEO who reflects their paradigm), are almost always made by committee.
Committees are by their nature almost incapable of contrarianism, which entails that the big capital allocation decisions of large corporations are generally not contrarian.
I would argue that in those rare instances where you have good capital allocators at the helm (eg. Berkshire, Leucadia, Power Corporation of Canada, Sampo etc.), then that can more than adequately compensate for a lack of competitive moat.
This is an excellent point you make Gareth. The greatest destruction of intrinsic value occurs when capital growth exceeds earnings growth. With hindsight most BHP shareholders would probably have been better off had China never expanded in the way it has since 2003.
BHP’s situation is probably different now though. I don’t follow BHP closely but I doubt BHP’s board and management will have a disposition for capital expenditure any time soon. As the focus naturally turns to cost control any commodity price relief will see a return to earnings growth in excess of future capital growth and a return to intrinsic value creation. I’m not predicting an earnings recovery but with capital expenditure already spent and likely subdued going forward the setting is in place for intrinsic value to return.
I also like SG’s observation about the importance of who makes the capital allocation decision. My twist would be that poor capital allocation decisions result from a lack of direct meaningful personal consequences of the decision maker/s and there is an overriding pressure for a business to keep growing. ASX listed owner operators types probably feel like the money is coming out of their own pocket when they allocate capital so the incentive is obvious and so they have some of the best rack records. Also by virtue of being listed for a period of time survivorship bias places them at the top of capital allocators in the country. When earnings growth exceeds capital growth meaningful intrinsic value is created. People like FLT’s Turner are such good operators because they spend so little capital to grow. It would be interesting to look at the capital expenditure record of someone like Don Argus when at NAB and BHP and compare who got what earnings growth for the capital they spent. Makes you think what could have happened if the $3 billion WOW spent on Masters was in someone else’s hands.