04/07/2012 - 11:05

Uncertain times true test of managers’ skill

04/07/2012 - 11:05

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Managers at the world’s big four miners have some tough decisions ahead.

Managers at the world’s big four miners have some tough decisions ahead.

SMALL mining companies are not alone in feeling the squeeze of lower commodity prices and uncertain growth prospects. Four of the world’s biggest miners are also being forced to make decisions that could blow-up in the face of senior management.

BHP Billiton’s challenge of having to decide whether to continue with three multi-billion dollar expansion projects (Olympic Dam, Port Hedland and Canadian potash) has been well reported, with one or two of the potential developments likely to be shelved because of shareholder pressure.

Rio Tinto management is yet to experience the same level of criticism from the owners of the business, but could soon if the iron ore price slips as it commits to a major expansion of its Pilbara operations, potentially turning the company into a one-trick-iron-ore pony with close to 80 per cent of its profits coming from a single commodity.

However, the two most interesting challenges are those confronting big miners not listed on the Australian stock market. Vale, which is headquartered in Brazil, and Xstrata, which has its head office in Switzerland, are also heading into uncertain times thanks to recent management decisions that do not appear to be fully-endorsed by shareholders.

Vale, which is trying to carve out a foothold in Australian coal and iron ore, last week gave another glimpse of its weakest link – close connections to the government of Brazil – which is causing a number of non-commercial decisions to be made that might be good for the country, but not the company.

Perhaps most worrying of all are Xstrata’s problems, and that it is taking the biggest risks of the four big miners at a number of levels. 

• It is trying to merge with its major shareholder, Glencore, on terms that have annoyed investors.

• It is persisting with a ‘second tier’ strategy better suited to boom times. 

• It has easily the most optimistic outlook for future commodity demand, meaning that it risks the biggest disappointment should prices stay flat, or fall further.

More on Xstrata/Glencore later; for now it is simply worth noting all four of the big miners are discovering that managing a business at a time of tightening profit margins and falling profits is a much tougher assignment than making easy money (and looking good) in a boom.

More importantly, these tougher times will ask difficult questions of management teams, which have not really had to make hard decisions because all the work has been done by high commodity prices – potentially exposing shareholders to risks that more cautious managers might not make.

BHP Billiton, for example, is in the middle of an intense owners versus managers debate with the board hearing (loudly) from shareholders that they are not keen on the wholesale expansion program preferred by management because that means delayed dividends. In turn, management wants expansion because that’s where the higher pay and bonuses come from.

Rio Tinto’s problem is that it made a number of bad decisions at the time of the GFC (phase one, that is), especially by diving headfirst into the aluminium industry just as the price crashed, effectively flushing away $40 billion of shareholder wealth. 

Today, it’s full steam into iron ore, a bet that could turn nasty if Chinese steel demand slows sharply.

Vale’s latest move to please the Brazilian government is to invest in the world’s biggest bio-fuels plant that will process palm oil, ostensibly to help cut the company’s fuel bill while also pleasing environmentalists.

 In reality, it’s a decision to impress the government because it means creating 6,000 farm jobs, which does nothing for Vale’s non-government investors.

Xstrata, however, is the most interesting example of management charging ahead with an aggressive growth strategy that has investors on edge.

The troubled merger with Glencore is one indicator of problems ahead. Persisting with a second tier asset strategy, in high-risk countries, is potentially much more interesting as resource nationalism and sovereign risk rises.

The forced surrender of a small tin mine to the government of Bolivia was a minor example to what happens when you do business is a risky country. A major investment program in strife-riddled Congo is another.

Good in good times, the Xstrata/Glencore approach of buying cheap and riding a rising commodity-price cycle works well. It will not work as well on the downward leg, which is a time when quality shines through – in terms of assets and managers.

French experiment

RISK is not confined to the decisions of capitalists. In France, the new socialist government is embarking on a program of remarkably risky experiments that could have a devastating effect on the country.

Among the programs starting to be rolled-out by the recently elected president, Francois Hollande, is a cap on executive salaries in state-controlled companies, with some bosses facing a 70 per cent pay cut – a popular political ploy but one guaranteed to see skilled managers (if there are any left) quit government service.

There are also new laws to prevent the sacking of workers, with one proposing to fine companies that lay off staff while still paying dividends to shareholders; effectively enshrining workers as the real controllers of a business. Managers who do make it to the top also face the prospect of a 75 per cent top tax rate.

Over the channel

LITTLE wonder that an exodus has started of talented managers from Paris to London, where British Prime Minister David Cameron has annoyed the French by saying he would roll-out the red carpet for escapees from this latest French experiment in socialism.

One-way traffic

BRITAIN is not the only destination for companies fleeing the rising tide of socialism in Europe. Singapore too is benefiting from higher taxes being levied on business as European governments try to tackle their debt problems.

Among the latest big name firms to call Singapore home is Trafigura, a major oil and minerals trader that has shifted its head office to Asia’s financial powerhouse thanks to tougher conditions on its business in Switzerland.

More European commodity related businesses can be expected to follow, attracted by competitive tax rates and the even more important factor – Asia’s commodity consumption is growing. Europe’s is falling.

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“Some cause happiness wherever they go. Others when they go.”

Oscar Wilde


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