Terry McCrann: Rio’s Pilbara iron ore and BHP’s US shale assets show difference between big miners

THE two big differences between our two major resource groups are the dominance of fabulously profitable Pilbara iron ore in Rio’s profit and asset base and BHP’s great big lump of indigestible US oil and gas shale, writes Terry McCrann.

THE two big differences between our two major resource groups are the dominance of fabulously profitable Pilbara iron ore in both Rio’s profit and asset base and BHP’s great big lump of indigestible — it will probably finally succeed in spitting it out this year — US oil and gas shale.

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BHP, of course, also has the same fabulous Pilbara iron ore; it’s just a tad slightly less fabulous and it’s not quite as dominant in its numbers as in Rio’s.

And apart from shale, it also has conventional oil and gas that Rio does not.

Yet despite Rio’s (slightly more) fabulous iron ore and BHP’s awful shale, we end up at a very surprising outcome at the endpoint that ultimately matters most: profit.

The BHP portfolio, warts — rather, wart, singular — and all, gave it a gross profit (EBITDA) margin of 53 per cent for the half year compared with only 44 per cent at Rio for the full year.

Rio “started with” an extraordinary 68 per cent gross margin from iron ore; BHP “started” only slightly lower at 60 per cent.

But even with the dominance of those iron ore numbers in the group outcome, the much lower returns from copper (39 per cent), energy coal (36 per cent) and aluminium (35 per cent), dragged the Rio group margin down to 44 per cent.

BHP’s other product groups have a bigger impact on the group result. But they also generate comparatively better returns, starting with coal at “just” 44 per cent and going to 56 per cent for copper and 57 per cent for conventional petroleum.

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Rio Tinto chief executive Jean Sebastien Jacques. Picture: Paul Jeffers

There’s an interesting puzzle with the huge difference between the two in copper, as they share the single biggest copper asset — Escondida in Chile.

The explanation is a reverse of the comparative importance of iron ore in the respective group results.

With BHP, the fabulously profitable Escondida is all-dominant; all the rest — even the (grossly) underperforming Olympic Dam — aren’t big enough.

In contrast, with Rio, its also fabulously profitable Escondida IS, and is significantly, diluted by the less profitable Kennecott and even more so by Oyu Tolgoi in Mongolia.

Now both — obviously they are joined at the hip — are committed to continuing investment in Escondida. But again, after that there’s a fascinating difference — Rio’s proprietary copper growth future is Oyu Tolgoi, BHP’s is Olympic Dam.

In both cases, again, perhaps — although it’s a bigger “perhaps” with BHP and Olympic Dam. Rio would reject the perhaps with Oyu Tolgoi; I’m a little more sceptical because of the “issues” it faces.

In both cases almost all the group profit increase came from higher prices.

With Rio, higher prices added $US4.1 billion to the full-year post-tax bottom line and “everything else” subtracted $US600 million.

Rio Tinto’s proprietary copper growth future is Oyu Tolgoi, BHP Billiton’s is Olympic Dam. Picture: AAP

With BHP, higher prices added $US2.2 billion to the (importantly) EBITDA line for the half (say, a similar $US4.4 billion on an annualised basis) but on a bigger sales base and at the EBITDA line not the tax-paid line.

Rio got the biggest kick from higher iron ore prices — $US1.9 billion.

BHP got only a negligible $US143 million from higher iron ore prices.

How come? Because Rio was comparing ALL of 2017 with ALL of 2016, while BHP was only comparing the December halves and the really big surge in iron ore prices took place from the first half to the second half of 2016.

So, again the interesting contrast: Rio got either “only” or an ‘impressive US$2.2 billion from higher prices on its portfolio other than iron ore; BHP got more than $US2 billion ($US4.1 billion annualised) from higher prices on the rest of its portfolio.

In Rio’s case it got $US1 million extra from higher aluminium prices — the metal on which Rio blew nearly $US40 billion buying Alcan finally came (half) good, thanks to some interesting developments in, where else, China.

In BHP’s case, its biggest price boost came from copper, Escondida, at $US1.3 billion ($US2.7 billion annualised); with a handy $US534 million ($US1 billion annualised) extra from higher oil and gas prices.

Where shale plays its biggest negative impact on BHP in comparison with Rio is in its capital allocation.

BHP Billiton chief executive Andrew Mackenzie. Picture: AFP

Last year Rio’s total capex was $US4.5 billion. Some $US2 billion of that went into sustaining capex — with much of that going into ultra-high margin iron ore and Escondida, all with an all but locked in high return.

Rio can then direct all of the other $US2.5 billion into (hoped-for) high return green and brownfields expansion.

BHP has the same capex profile in Iron ore, Escondida, but also conventional petroleum.

Whether sustaining, or expansion, or greenfields, it’s aimed at high-margin returns.

But then it also has that indigestible lump to make a bit of a mess of the group capex allocation. Shale is high maintenance and ultra low margin.

Over the full year BHP will “invest” $US1.1 billion into shale and it will be lucky if it washes its face in cash (EBITDA) terms.

It really is an indication of the quality of the rest of BHP’s portfolio, how well it performs (especially relative to Rio) despite the shale.

Shale is both significant enough to drag down group performance, but not big enough to really drag it down.

Once BHP sells it, and it will — it must — some time in 2018, it will have stopped banging its collective corporate head against a brick wall. Then it can think about the even more vexing issue of its dual listing, as indeed does Rio.

They both have to abandon it to get capital clarity. They both have to keep it for major tax advantages — both, the same (franking); and also, somewhat different (where the “parent” company is located).