Australia’s share market is dominated by two ends of the same barbell.
Ever since the end of the mining investment boom the mining end of the barbell has been dipping worryingly lower as the big banks continued to build momentum and profits.
Now the barbell is starting to level out again as the big miners stage an exceptional comeback while the big banks are suffering under the glare of the Royal Commission and a much flatter property market which is restricting lending.
Shareholders in line for $18.7 billion
Patient shareholders who weathered the post mining boom storm are being rewarded with an amazing $18.7 billion in dividends and share buybacks from the two big miners this year alone, with the promise of more to come over the coming years.
Plus BHP is now the big international Australian once more, with its market capitalisation now pulling ahead of Commonwealth Bank (ASX: CBA) again.
The key to the big comeback of the mining giants is that they have made their own luck by greatly improving efficiency and slashing costs.
Recovering commodity prices have played a part but they are good rather than spectacular while the sort of adventurism of “buying up big’’ during the boom has departed from BHP and been replaced by a much more disciplined focus on costs.
Rio Tinto grabs early gains but BHP improving fast
While Rio Tinto entered its clean-up phase earlier and has been enjoying the rewards for longer, it is BHP’s chief executive Andrew Mackenzie who has really turned the ship around, slicing off the significant but smaller mineral businesses into South 32 (ASX: S32) and finally ridding BHP of its troublesome US shale oil and gas assets for a reasonable but still much lower price.
The result is an exceptional return on capital of 14.4 per cent which would have been 18 per cent with the US shale oil assets stripped out.
That means the return on capital is getting closer to Andrew Mckenzie’s aim of 20 per cent by 2022, which is a number that would beat the Commonwealth Bank at its best if it can be achieved.
Numbers tell the story
If we look further at BHP’s numbers they show the benefit of Mckenzie’s aim to greatly simplify BHP and bring it back to four key commodities – all produced from large, long term and high quality assets.
Pre-tax margins tell the story with iron ore running at 61 per cent, copper at 54 per cent, coal at 49 per cent and oil and gas at 62 per cent.
That is a beautiful set of numbers but behind it is a story of radical cost cutting and investments in productivity to achieve these great results.
BHP’s majority 57.5 per cent stake in the giant Chilean copper mine Escondida is a great example.
Escondida a productivity marvel
While Escondida is and remains one of the world’s truly great copper deposits, the really easy money is behind it with copper ore head grades now waning.
That means you have to mine and mill a lot more ore to get the same amount of copper and you need to be very careful to contain costs.
BHP has done that brilliantly with the expansion program – which initially greatly reduced copper output – now producing some great results.
That expansion allowed Escondida to produce 57 per cent more copper in the 2018 financial year than it did in the 2017 financial year.
More importantly, the mine produced 1.2 million tonnes of the red metal which is the same as it produced in 2006, even though copper grades have halved in that time.
Will the big miners make a big purchase?
Perhaps the most interesting question is whether BHP – or Rio Tinto – will now have an appetite to buy a really significant asset if one came up for sale or would they be brave enough to branch out into another commodity?
Certainly they both now have low debt levels and stellar cash flow so they can afford it but both companies have in the past squandered their gains through unwise acquisitions – BHP’s US shale oil purchase and investments which chewed through the best part of $50 billion being the most recent example.
For the moment though, both of the big miners are going to be in the very rare position of throwing plenty of excess cash flow to investors in the form of higher dividends and more share buybacks.
Naturally commodity prices are still key for both BHP and Rio Tinto but they have both made their own luck in the downturn and really have cut their way to greatness and much higher shareholder returns.