BHP and Rio: resources gods know how to balance ledger

Just as worms turn, they turn again and there are signs the iron ore market is recovering.

Miners’ slide

BHP Billiton (BHP) $16.20
Rio Tinto (RIO) $41.62

How the worm turns. At the fag end of the bull market in 2007, BHP launched its audacious takeover offer for the stricken Rio, in view of forming a $200 billion global giant on very much its own terms.

At the time — amid the unfurling GFC — Rio was drowning in the debt incurred from the ill-timed $US38bn acquisition of the Alcan aluminium business.

For Rio, the Alcan disaster — and the ill-fated $US4bn purchase of African coal producer Riversdale — led to a period of introspection and cost-cutting under new chief executive Sam Walsh.

The resources gods have a habit of balancing the ledger and now it is Rio looking the cleaner and nimbler of the two mining pillars. And having forgiven BHP for the multi-billion dollar snafus such as Ravensthorpe nickel, the deities have made amends by bestowing the Brazilian tailings dam disaster just as the oil and iron pain intensified.

Next Thursday’s full-year result from Rio will show the extent to which the smaller pillar of the mining establishment is outperforming its hitherto impervious peer.

While the market’s focus is on the extent to which BHP (Tuesday fortnight) will abandon its once-sacrosanct progressive dividend policy, Rio’s strong cash flow means it’s in a position to maintain its payout.

Rio is a bigger iron ore producer than BHP and in calendar 2014 the ferrous dirt accounted for 77 per cent of Rio’s underlying earnings.

Ironically, BHP had the supposed benefit of its oil exposure to offset weaknesses in its mined commodities, cementing the advantage with a $US20bn acquisitive splurge into US shale oil in 2011.

Whoops again.

A year ago, oil and gas accounted for 20 per cent of BHP’s EXIT.

This financial year, Credit Suisse expects the petroleum division to lose $US359m ($795m), with BHP’s overall EBIT shrinking from $US9.93bn to $US3.5bn (down 65 per cent).

This month’s first-half number is tipped be even worse: down 77 per cent to $US1.95bn with the dividend halved to US31c a share.

Just as worms turn, they turn again and there are signs the iron ore market is recovering — or at least stabilising — as the high-cost producers curtail output.

On the oil side, it is hard not to see production cutbacks to soak up the inventories overflowing into global storage tanks.

Given petro-politics involve the Arab world, the Russians, the Iranians and Texan oilmen, it’s also hard to see the competing parties linking arms around the negotiating table.

Still, pragmatism has a habit of prevailing.

In the meantime, both BHP and Rio should be happy to chug out massive tonnage of iron ore at sub $US20 a tonne production costs while lesser rivals wither.

Thus, Criterion maintains his hitherto fruitless long-term buy call on BHP and rates Rio as a hold.

Programmed Group (PRG) $1.10

Still on oil — and poorly timed M&A — the facilities management group has been seen as a proxy for the ailing oil price given its exposure to oil and gas via support services for offshore rigs.

Having acquired Skilled Group last year, Programmed chief Chris Sutherland protests that two-thirds of group revenues derive from healthier non-resource sectors such as healthcare, education and tourism.

“Many operators are putting a lick of paint on their assets again,’’ he says.

But investors aren’t listening, judging from the 62c, 34 per cent sell-off since last Thursday’s supposedly soothing business update.

The update included a $75m writedown of the oil business, predominantly the Darwin-based, oil-focused Broadsword vessel business Skilled acquired for that amount in mid-2013.

Management also flagged $100m-$110m of EBITA for the year to March, below the expected $110-120m. Roughly speaking, the number is similar to the collective earnings of Programmed and Skilled in 2014-15.

The combined business was meant to have a market cap of about $800m but the 60 per cent erosion since the deal was completed means the entire worth of Skilled has disappeared into the ether.

At face value, the sell-off looks overdone and we maintain a long-term buy call presuming no undisclosed nasties.

The Australian accepts no responsibility for stock recommendations. Readers should contact a licensed financial adviser. The author holds BHP Billiton shares.