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BHP Billiton reveals it is growing profits again and confirms spin-out plan

Published: 07:37 19 Aug 2014 EDT

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Financials from BHP Billiton (LON:BLT) reveal the Anglo-Aussie miner has turned a corner and is again growing its bottom-line.

BHP has reversed the slide of the past two years with a 10% rise in the underlying attributable profit to US$13.4bn for the year just gone, which is slightly better than most experts expected.

Indeed, VSA Capital analyst Sheldon Modeland says BHP is again showing the economies of scale and asset quality of a ‘tier one’ company.

BHP this morning also confirmed plans to split in two, spinning off its non-core businesses.

The new unit, which will be listed in Sydney and Johannesburg, will comprise the group’s South African aluminium, manganese and coal businesses, as well as the Cerro Matoso nickel mine in Colombia, the Australian Cannington silver mine and the Illawarra coking coal mine.

For the mining sector this is something of a different approach, for a different time.

A little over five years ago, acquisition and consolidation was very much the order of the day – at that time BHP was chasing Rio Tinto and looked set to create a titan of a mining company.

This, of course, was before global markets did the unthinkable and questioned the sustainability of China’s double-digit (percentage) GDP growth. Also the sector still had a firm conviction that we were set for a commodities ‘super-cycle’.

Now, in less certain times, the strategic emphasis is on simplicity and efficiency – on maximising value from existing production and developing only the most rewarding projects.

Aside from its de-merger plans, BHP has already slimmed down with US$2.9bn of cost efficiencies in the past 12 months, taking the running total to US$6.6bn over the past two years.

It is still targeting a further US$3.5bn of savings - eyeing cuts to capital expenditure (i.e. spending on new projects) and operating costs.

Today’s figures reveal a 32% drop in capex to US$15.2bn.

The Anglo-Aussie digger, meanwhile, targets capex of US$14.8bn next year and by the time the aluminium and nickel spin-off is executed it should be down to US$14bn – which by anyone’s standard is still far from an insignificant level of annual investment.

As a result, the subsequently skimmed miner is predicted to have particularly strong cash flows.

Though unlike the custom in the mining sector, where the majority of cash has typically been ploughed back into the next big project, BHP plans to enhance pay-outs to shareholders.

In terms of direct payment BHP today announced it was raising its dividend by 4% to US$1.21 per share, whilst promising a more significant return of cash once net debt is below US$25bn. The results revealed the figure to be US$25.8bn.

“We will return excess cash to shareholders in the most efficient way,” it said.

City experts anticipate BHP will turn to the stock market as a means to ‘reward shareholders’ by buying back its own shares.

It is certainly one of the easiest options to execute and to some extent it lessens the amount siphoned off by corporate middle men – however, many investors who would prefer straight cash pay-outs have long questioned the effectiveness of buy-backs.

Nevertheless, UBS analyst Myles Allsop says: “We forecast BHP to generate US$8bn in free cash flow (FCF) over the next two years which could be used to fund a US$5+bn buyback starting with an on-market buyback in London, followed by an off-market in Australia when balance sheet position allows.

So what does the shift in strategy mean for small cap miners?

Many small cap explorers and miners, of course, rely heavily on partnering with larger companies.

By teaming up with a major, the smaller exploration specialists are able to reduce the project financing burden and gain access to valuable expertise.

And, naturally, for investors in the junior partner, there’s always the hope that one day the deep-pocketed major will buy them out.

So, is greater capex stringency bad for small cap businesses?

Well, on the face of it is fair to conclude that less cash is sloshing around for new projects – but, then, that’s been the case for some time already.

BHP is not the only mining major to start holding the purse strings tighter and, indeed, across the whole sector there is now a great deal more capital discipline.

Less popular are the giant deposits in the African jungle as there’s less appetite to spend billions on the accompanying infrastructure projects. Instead, such projects appear destined to remain on the drawing board until metal prices improve and the longer term economic landscape is more predictable.

In such an environment the emphasis is increasingly on resource grade and deliverability; in other words those with good, easy to access projects will still be in high demand.

At the same time, of course, the drive for efficiency itself creates its own opportunities.

For a large metal producing miner, with heightened emphasis on efficiency and maximising returns, the business of exploration is likely to appear particularly wasteful and costly.

Instead, they’re increasingly leaving exploration to the independent explorers and subsequently cherry-picking the best available projects. By effectively out-sourcing the exploration function in this way the likes of BHP are able to develop a more capital efficient development pipeline.

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