25/02/2014 - 06:02

Wheels within resources wheels

25/02/2014 - 06:02


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The cost-cutting phase of the current resources cycle has been a ‘success’, and an upswing could be just around the bend.

Wheels within resources wheels

If proof were needed that the commodity super cycle is not dead, merely resting, consider the latest evidence provided by the strong profits of Western Australia’s two biggest miners, and the remarkably strong level of Chinese commodity imports.

All three – the profits of BHP Billiton and Rio Tinto, and record levels of imports by China during January – are good news for the state, even if the beneficial effects are not being felt by many who live in WA.

The big winners from what’s happening here and in China are investors in mining and oil companies, as those companies effectively re-set the meter on their operations, which means stripping out costs, delaying expansion plans and mothballing exploration.

That process of cost cutting, which lies behind the higher profits and fatter dividends, cannot last forever because a company that cuts too far, and forgets how to grow, will eventually disappear.

BHP Billiton and Rio Tinto, which dominate the WA resources sector with their iron ore, nickel, diamond, alumina and salt operations, are not about to disappear but they will eventually hit their cost-cut targets and investors will eventually want to know when the next growth phase is coming.

The answer to that question is ‘sooner than you think’; and while it is not easy to feel optimistic about resources in the week after the shameful collapse of the Forge construction contracting business, and the financial stress being felt at vanadium producer Atlantic, there are indications pointing to an earlier-than-expected recovery.

Top of the clue list is the speed at which Rio Tinto and BHP Billiton have stripped costs out of their various business units, and the relatively handsome profit margins being generated through what is widely seen as the sharpest downturn in a decade.

Rio Tinto, for example, said it would remove $US2 billion from its costs in 2013. It did 15 per cent better by removing $US2.3 billion. It also beat investment bank profit projections and paid a higher-than-expected dividend at $US1.92 per share.

BHP Billiton, in its half-year report, performed an almost identical trick, boosting underlying pre-tax earnings by 15 per cent and achieving $US4.9 billion in what it terms ‘cost efficiencies’. Shareholders were rewarded with a 3.5 per cent increase in their interim dividend.

Meanwhile, in China, commodity demand remains extraordinarily strong despite concern about WA’s biggest customer entering a period of slower growth after a hectic decade of near double-digit annual expansion.

While no-one expects China to expand forever, there is no doubt the task the Chinese have set for themselves – the modernisation of a primitive economy – is not even half done, particularly as failure to complete the job risks social unrest, which is the great fear of leadership in that country.

What we’re looking at is a series of cycles that has half-turned. The big miners flipped from growth to cash retention in mid-2012 and by mid this year will be two years into a campaign of cutting costs in order to reward shareholders.

China, too, flipped from a growth-at-all costs period to set itself more sustainable targets that did not (a) blow-up the economy like the US did in 2008 with its banking crisis, and (b) totally despoil its environment to the point where major cities become unliveable.

Nothing that has happened over the past two years can be considered economically unhealthy. It is largely a case of rebalancing.

A second clue that the resource sector wheel will soon include more growth and less cost cutting is that the big miners are quietly starting to recruit talented staff.

Having emptied their offices and work sites of people surplus to requirements, the inevitable is happening as management discovers that all companies need skilled employees to run the business.

Party’s over

Australia was late to the renewable energy party thanks to its abundant supplies of coal and gas, and if we’re not careful we’ll miss the call from the markets that the party is over.

Around the world there are warning bells ringing that renewables are simply not delivering, either in terms of reliable electricity supplies or in terms of price.

Reliability was always going to be the Achilles heel of wind and solar power for the obvious reason that they need either sunshine or wind to work, and when one (or both) fail to appear the electricity system is forced to fall back or coal, gas, or the environmentalists’ number one enemy, nuclear.

Today, the cost factor is rearing its head as governments add up the price of believing the pro-renewables case, only to discover that subsidies are higher than expected and will have to be provided for longer than promised, and that renewable power is a thoroughly lousy investment, even with taxpayer subsidies.

Recent examples include British taxpayers being asked to provide an extra helping hand to Scottish wind turbine operators, and in Germany where a detailed study into the economics of wind power has produced a damning finding.

The German analysis, based on a detailed examination of more than 1,000 annual reports from wind energy companies by the investment committee of the German Wind Energy Association, found that the average annual return on an investment equated to 2.5 per cent – a fraction of what was promised.

The question now is whether the German government will boost its subsidy assistance for renewable power production or succumb to the inevitable conclusion that it is backing a horse with no power.

Golden Chalice

The rebound in the gold price has brought smiles to a few faces in West Perth, none bigger than that of Tim Goyder, chairman and major shareholder in Chalice Gold.

Not only has Chalice been able to preserve the $55 million generated by selling a gold asset in Africa to a Chinese investor, it has found a sweet (but small) gold project in Canada.

Adding to the appeal of a stock that has flipped the third world for the first world are advantages that start with cheap power and a skilled workforce, and a share price around 17 cents, which is 2 cents less than the implied 19 cents/share backing from the cash in the bank.


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