One major point is clear from the $US90 billion proposed Glencore takeover of its 34% owned associate Xstrata and that’s BHP Billiton and Rio Tinto should have no fear of the combined group which will be a second class competitor.
BHP CEO Marius Kloppers was clearly unworried by Glenstrata, as he told analysts on Wednesday.
"People have asked me does this deal make a difference to you, and I would say it doesn’t make difference to our strategy, it doesn’t make a difference to our philosophy," he said.
Nor will the world’s other resources giant, Vale group of Brazil, feel threatened.
The merged company will move into Number four spot globally, providing it’s approved by shareholders and regulators, pushing Anglo American down to five.
The vertically integrated business that Glencore and Xstrata are pushing, combines a commodities trader with a miner and according to the publicity, aims to capture each and every dollar along the supply chain.
That’s an ambition that will remain unmet: the history of resource companies is that the big profits go to the miners; especially those with world class, low cost operations, like BHP and Rio have in some key commodities.
Traders can make good profits, but nowhere near the super profits that BHP, Rio and Vale have been earning in the last three years as China’s boom has grown.
And while an impressively large business, Glenstrata will lack a major profit driver or two in coming years.
In fact the combined Glenstrata, as it’s being termed, will be very weak in two key commodities: iron ore, and oil and gas.
In iron ore, it is all but absent – Xstrata has started producing a tiny 1.2 million tonnes a year from one of its Australian mining operations, while BHP and Rio produced over 400 million tonnes last year.
BHP and Rio dominate the iron ore industry, along with the Vale company of Brazil.
All three companies are expanding their iron ore businesses to make sure they remain the global cost leaders, which will enable them to continue in business if prices slump sharply.
Based on their latest results this week, BHP and Rio have iron ore earnings of well over $US30 billion at the moment, a sum that Glenstrata can’t find because its iron ore presence is minimal.
That puts it behind the eightball.
Glenstrata can start buying iron ore companies (Fortescue Metals comes to mind), but that will mean it becomes a high cost producer, compared with BHP, Rio and Vale which have huge, low cost mines.
Iron ore is perhaps the most profitable commodity around thanks to the boom in Chinese demand in recent years.
India will emerge as a significant buyer in the next five years as well.
This week’s financial figures from Xstrata, BHP and Rio clearly illuminate the Glenstrata’s weakness and why it will struggle in future years.
Take Glencore and Xstrata first.
According to figures released this week with the merger proposal in London, Glencore said it generated revenues of $US186.2 billion and adjusted EBITDA (before exceptional items) of $6.5 billion for the 2011 year.
For the 12 months ended December 2011, Xstrata generated revenues of $US33.9 billion and EBITDA (before exceptional items) of $11.7 billion.
On a combined basis for the year ended December 2011, the Combined Group would have generated revenues of $US209.4 billion and adjusted EBITDA of $16.2 billion.
Now that’s pretty impressive, but compare that to BHP’s performance in the December half year in just its iron ore business, and the above results look light on.
BHP
made $US7.9 billion in earnings before interest and tax from iron ore alone in the six months to December. (Add the undisclosed depreciation in and the figure could be closer to $US9 billion.)
Annualised, BHP will earn close to $US16 billion this year, or about what the combined Xstrata and Glencore earned all of 2011, from all their operations.
BHP’s profitability was underlined by the fact that the near record EBITDA of $US18.7 billion for the first half was earned on a 9.7% improvement in group revenues to more than $US37.4 billion.
That’s a profit margin of 50%. BHP’s iron ore business had profit margins of 65% in the December half year ($US7.9 billion on revenues of $US12.14 billion), up from 62.8% ($US5.8 billion on revenues of $US9.38 billion) in the December 2010 half year.
By way of contrast the combined Glenstrata had a margin of just 7.75%, with Xstrata’s margin of 33% by far the best of the two companies.
Glencore’s returns are depressed by the fact that its sales include the billions of dollars of commodities it trades, but on which it only generate small fees.
It does own some mines (such as the Minara laterite mining business in WA) and it does buy commodities as a principal, but that means it still misses the bulk of the profits being generated by miners like BHP and Xstrata.
Rio Tinto, which reported its 2011 earnings yesterday (see the above story), depends far more on its iron ore business than BHP does.
It doesn’t have BHP’s huge spread of resources, especially limited coking coal assets and no oil and gas.
Rio said its iron ore business has EBITDA of $US20.01 billion, up from $US15.14 billion in 2010.
That’s a gross profit margin of 74.5%, in sales of $US26.8 billion, up from 2010’s very rich 71.8% in sales of $US21.07 billion.
There is nothing in the Glenstrata portfolio of businesses that can match th
