BHP and RIO: “Bottom line is I think there are higher-quality businesses to invest in” says seasoned fund manager Ronni Chalmers, Chief Investment Officer, CBG Capital Limited (CBC).
“BHP being in the mining industry by nature is not a real high quality business, and in addition over 50% of the profits come from iron ore. The iron ore price is so volatile, it can move 3% or 5% up and down in a day….and most people are not predicting steel production in China to grow at 7% anymore.” says Chalmers
“We have a modest position in BHP, we took a view around a month ago that we would trade a few, buy a few. In the short term we will sell out….we’re not likely to be there in six months’ time.” Continues Chalmers.
Recent BHP and RIO Rally
Shorter-term traders have made some good money on BHP and RIO from their recent rally. This has buoyed investor’s confidence in repairing some of the damage these two shares have inflicted on portfolios over the last two years.
Although the rally looks to be a short-term reprieve. “Frankly there has been a modest positive change in supply/demand in iron ore which has led to a disproportionate rise in the iron ore price.” Says Chalmers.
News behind the recent iron ore rally
“On the positive; China steel production has gone back into positive growth after a few consecutive months of falling output.” Says Chalmers.
Also as the AUD fell on the RBA interest rate cut and expectations of further cuts in the shorter term, this also helps the profits of BHP and RIO earning in $AU selling in iron ore in $US.
Global miner’s iron ore output
Chalmers continues “Looking at the Big 5 iron ore producers around the world, they’re all is still growing their iron ore output volumes”.
“Roy Hill – Gina Rinehart’s mine – is looking to double their output over the next year from 25million tonnes to 55million tonnes.” Says Chalmers who also notes that the Brazilian miner Vale and Fortescue (FMG) are both increasing their outputs.
Although BHP and RIO helped fuel the iron ore rally when they both announced a drop in their iron ore output. “About a year ago, the market was expecting 5-7% iron ore growth tonnes p.a., now it’s going to be about half that.” explains Chalmers.
BHP’s outlook
With 50% of BHP’s profits coming from iron ore with a bleak outlook, investors are looking to BHP’s other divisions of copper and oil & gas for profit growth.
BHP’s copper business is quite good. BHP have to cut the cost in the copper division down to about a $1 a pound. With the current copper price about $2 a pound, that has become quite a good profit, but the copper division is less than 20% of the total company’s profit” says Chalmers.
“The balance of BHP profit is about 30% which is essentially oil and gas. That division is quite good, with their cost being under $20 a barrel against the current price of about $46 a barrel. Although some of these oil fields have a relatively short life. BHP are looking to develop new projects which will be profitable at current market prices” explains Chalmers. Although these newer projects are not expected to generate the same amount of profit as the current oil fields.
BHP’s balance sheet
After the spin-off of South 32 (S32) a lot of shareholders have been a little confused about BHP’s balance sheet.
“One of the things that I don’t really like about BHP is that they still have $24billion of debt. That’s a debt to equity ratio of 43% which I would describe as a little on the elevated side.”. Chalmers continues “At current spot (market) prices of iron ore, copper and oil and gas, you need to look out to 2019 until BHP’s current debt drops below $20b.”
RIO’s balance sheet
“When comparing RIO’s balance sheet to BHP’s, RIO has a very under-geared balance sheet.” Says Chalmers.
“Neither of these global mining companies have (credit) issues, but they don’t offer you a lot of diversification… RIO is nowhere near as diversified as BHP because RIO makes 70% of its profit from iron ore.” Continues Chalmers.
Growth outlook for BHP and RIO
Many investors look at BHP and RIO for 100% upside in the next year or two. That’s after taking the view that now BHP and RIO’s share prices have fallen so much, they must now be great growth stories.
Both companies are contingent on a strong iron ore price, or pulling something impressive out of their bag of tricks, although that bag looks pretty empty. There is little chance of a strong catalyst to spur these share prices higher “RIO is seeking modest sized acquisitions, while BHP is concentrating more on organic growth. Both of those strategies are fine, although neither of them are going to do massive M&A (mergers and acquisitions) at the moment.” explains Chalmers.
With such uninspiring outlooks for BHP and RIO, most investors question are ‘where else do we invest afterwards?’. Who knows, maybe they’ll look at Chalmers’ listed investment company (CBG Capital) which is trading at a 6% discount to what is a basket of blue-chip shares that outperformed the market by 1% over the last year?
