CONNECTION: The fortunes of the top resources companies and those of the state are closely linked. Photo: Attila Csaszar

Resources players light the way

Wednesday, 9 November, 2016 - 16:19

The performance of five of WA’s major resources players provides a useful guide to the overall direction of the state economy.

One look at the neon signs and corporate logos that dominate the Perth skyline leaves a first-time visitor in no doubt that the resources sector is the principal driver of the Western Australian economy – not that the names provide a guide to who’s really on top.

Reporting season, including the recent burst of quarterly production reports by the miners and oil producers, has helped separate WA’s resources sector leaders from the followers, with surprising results.

BHP Billiton, for example, might have the biggest sign and is widely considered to be the world’s biggest resources business, but it is a country mile behind two smaller companies with their names on city buildings when it comes to measures of financial performance and share price growth.

Fortescue Metals Group and South32 have significantly outperformed BHP Billiton during the past 12 months, and seem likely to remain in front as low oil prices and the threat of heavy penalties hang over BHP Billiton in the aftermath of the Samarco tragedy in Brazil, when a ruptured dam at an iron ore mine engulfed a village, killing 19 people.

Rio Tinto and Woodside Petroleum are two other resources companies with their names up in lights, though they, too, fall behind Fortescue and South32 on the latest financial performance measures.

Before looking at the results, it is worth considering why a test of the high-rise self-promoters is both interesting and possibly important.

The interest lies in the way resources companies dominate the WA economy (and the Perth skyline), outshining business names seen prominently in other Australian cities, such as banks and insurance companies.

The importance is that the financial performance of the resources companies is a useful measure of the health of the WA economy, because rising profits and higher share prices are a guide to the direction of local wealth and job creation.

Share prices, in particular, are widely believed to be a leading indicator of where investors see a company’s performance in six to nine months.

What the skyline test reveals is that, after several bad years, WA is starting to shake off the worst effects of the commodity price crash, which rattled every business in the state, sent a shock-wave through the budget, and could lead to a change of government at next year’s election.

Simply put, if the big resources companies with their names in neon are doing well, then WA will also do well – a variation on a famous comment about big US carmaker General Motors by a 1950s chief executive: “What’s good for General Motors is good for the country.”

In effect, the ‘neon test’ can be seen as a private sector proxy for the wider WA economy, perhaps not right now but most probably in the near future.

The five companies chosen in the neon test of WA’s future are collectively much bigger than the WA government, with combined annual revenue approaching $200 billion and a combined stock market value also close to $200 billion.

Not all of the business units of the companies being analysed are in WA, but a lot are; and even if you cut the revenue and market capitalisation numbers in half, the $100 billion left over is four times the size of the WA government’s annual revenue of $25.7 billion, as revealed in the 2016-17 budget.

All five companies in the neon test are in the list of the top 25 stocks listed on the Australian Securities Exchange, though BHP Billiton and Rio Tinto confuse that pecking order by having some of their shares listed on the London Stock Exchange.

Adding both sets of Australian and London-listed shares leaves BHP Billiton as Australia’s second biggest company, worth around $115 billion and topped only by Commonwealth Bank. Rio Tinto is second in the neon-test list at $79 billion, followed by Woodside ($24.7 billion), Fortescue ($15.9 billion) and South32 ($13.9 billion).

When subjected to a performance test, however, it is the two smaller companies that shine the brightest – Fortescue and South32.

The share price at Fortescue, which is a pure-WA business, has risen by an eye-catching 255 per cent since early 2016, when it had slumped to a multi-year low of $1.44.

Falling costs and a rising iron ore price are driving Fortescue’s earnings, which rose by an equally impressive 210 per cent to $984 million in the financial year to June 30.

Profit in the current year should be even better, with Deutsche Bank tipping a rise of 36 per cent to $1.3 billion. And while future earnings might decline if demand for iron ore slips (or production by other miners rises too quickly), the key point is that Fortescue’s survival seems assured.

That was not the case at different times over the past five years, as Fortescue laboured under a heavy debt burden and the iron ore price appeared set to fall off a cliff.

Rising profits, and the closely associated rising share price, are a clear indication that not only is the worst of the slump behind Fortescue, but the future looks brighter than it has for some time.

The Andrew Forrest-led business alone is not a proxy for WA, but a more accurate picture of revival becomes clear when it its success is incorporated with the other resources-focused companies, even of it is not yet being felt by most workers, or the state government.

After Fortescue’s strong performance comes the newest business, South32, a company made up of business units that were once part of BHP Billiton and include the Worsley alumina refinery in WA’s South West, along with coal, nickel and manganese assets in the eastern states, South Africa and South America.

Since the start of the year, the South32 share price has risen by 200 per cent – from a low of 87c in early 2016 to recent trades at $2.61.

As with Fortescue, the percentage rise of South32 provides a distorted picture thanks to the low starting point, but the price recovery can also be seen as a pointer to where the WA economy is heading. After the post-boom malaise, the outlook is more positive than it has been for several years.

The other three companies in this neon analysis have performed well, as their share price graphs reveal a rising trend with the increase from the low point to latest trades.

BHP Billiton’s share price is up quite strongly from its low, which was reached in the aftermath of the failed progressive dividend policy – a management promise that the company’s annual dividend would never be cut, which it was when profits fell faster than expected and the Samarco disaster damaged earnings and the reputation of the people responsible.

Since trading down to $14.06 in January, BHP Billiton has been on the rise thanks to an overall 26 per cent increase in commodity prices. The stock is up 64 per cent at its most recent sale price of $23.04, with that increase a combination of the low starting point and an expectation of higher profits in future years.

Rio Tinto, which, like BHP Billiton can be seen as a form of proxy for WA, has returned a share price gain of 39 per cent since reaching a low point of $36.53 at the start of 2016, after which a recovery set in (with latest transactions priced at $50.95).

Woodside, a pure oil and gas producer with the lion’s share of its assets in WA, has been the weakest of the WA proxy list with a share price rise of 23 per cent from a low of $23.82 to latest sales at $29.30.

Factors weighing on Woodside are dominated by the underlying oil price, and a belief among investors that the company is struggling to find ways to grow in a low oil-price environment.

What happens next is a question that should interest everyone in WA, because while profits and share prices have bounced off their cyclical lows, it is uncertain whether the revival can continue as strongly; or whether WA and its resources leaders are in for a long, slow, grind up.

In other words, the past 10 months have shaken off the worst effects of the crash that followed the boom. However, the next 10 years are likely to be far less exciting, a time of steady growth – until the next boom (and bust), which is the nature of commodity-exposed economies.