BHP Poised to Boost Production, Grow Earnings

By David Dittman • January 23, 2013 • Pacific Digest

AE Portfolio Aggressive Holding BHP Billiton Ltd (ASX: BHP, NYSE: BHP) is widely expected to follow fellow Aggressive Holding Rio Tinto Ltd (ASX: RIO, NYSE: RIO) with a significant writedown of the carrying value of resource assets when it reports full financial results for the six months ended Dec. 31, 2012.

Rio Tinto, the day after it reported solid output growth from its key iron ore unit, announced that it would book a total of USD14 billion in non-cash charges on recent aluminum and coal acquisitions. Tom Albanese subsequently resigned his position as CEO of the company, giving way to Sam Walsh, who previously headed Rio’s iron ore unit.

The biggest share–about USD10 billion to USD11 billion–relates to Rio’s USD38 billion acquisition of Canada-based aluminum producer Alcan. Mr. Albanese led this deal to completion in November 2007, when commodity prices were peaking and a global competition for resource assets was reaching high gear.

Mr. Albanese took no bonus for 2012 after Rio wrote off USD8.9 billion on Alcan. Total charges are now approximately USD28 billion.

About USD3 billion of the USD14 billion is based on a reduced estimate of the book value of coal producer Riversdale Mining, which is based in Australia and manages mines in Mozambique. Management attributed its failure to secure local government approval to ship coal it mined in the African country. Rio Tinto also overestimated how much coking coal it could recover there.

Rio bought the African coal asset for around USD4 billion in 2011, boosting its offer to win over holdout Riversdale shareholders. Chairman of the Board Jan du Plessis described the scale of the Mozambique writedown as “unacceptable.”

Management cited strong currencies and high energy and raw materials costs as other factors leading to the writedown. Doug Ritchie, a Rio Tinto executive who led the purchase of coal assets in Mozambique two years ago, also resigned.

Rio shares have responded positively in the aftermath of the writedown and management changes, rising from a close of AUD64.60 on the Australian Securities Exchange (ASX) on Jan. 17, the day of the announcement, to AUD66.45 as of Jan. 23. Management is exploring its options for the Mozambique assets, including the possibility of taking on a local partner or putting them up for sale outright.

BHP, meanwhile, will likely reduce the value of its Australian aluminum and nickel assets by about AUD3.8 billion, according to analysts who’ve studied the issue, due to continuing strength of the Australian dollar and continuing weak prices for the two base metals. These potential writedowns aren’t related to acquisitions made so recently, which is why CEO Marius Kloppers won’t walk the plank for them.

Mr. Kloppers is, however, in the crosshairs for writedowns related to BHP’s recent shale gas acquisition in the US. A recent rally in US gas prices and expectations for still higher prices in future have improved the prospects for the Fayetteville Shale assets purchased from Chesapeake Energy Corp (NYSE: CHK) in mid-2011 for USD4.75 billion.

These assets were written down by USD2.8 billion in August 2012 and cost Mr. Kloppers and the head of BHP’s petroleum unit Michael Yeager their bonuses.

BHP management delivered a solid mid-year production report this week, with results for its core iron ore, coking coal, copper and petroleum assets meeting analyst expectations. Production results for its least profitable businesses–aluminum and nickel–were impressive but not good enough to overcome external pressures of a high currency and still-murky global economic conditions.

BHP posted petroleum production of 121 million barrels of oil equivalent (MMBoe) during the six months to Dec. 31, 2012, putting the diversified resources giant on pace to meet fiscal 2013 full-year guidance of 240 MMBoe. Quarterly petroleum production of 59.9 MMBoe was up 3 percent compared to the second quarter of fiscal 2012.

Liquids volumes–including crude oil condensate and natural gas liquids (NGL) increased by 4 percent during the three months ended Dec. 31, 2012, from the fiscal 2013 first quarter. Management noted continuing growth at its onshore US liquids assets as well as successful development drilling at Shenzi and a full quarter’s contribution from the Atlantis and Mad Dog facilities. The latter three projects are located in the deepwater US Gulf of Mexico.

BHP posted a 13 percent sequential increase in onshore US liquids production. Management expects “a focused drilling program” in liquids-rich areas of the Eagle Ford Shale and the Permian Basin “to drive strong growth” in fiscal 2013.

Lower gas production in fiscal 2013 second quarter reflected a seasonal reduction in demand for

Bass Strait output that followed a particularly strong first quarter.

Mined copper production of 295.2 million metric tons (MMmt) was up 8 percent quarter over quarter. Output for the six months to Dec. 31, 2012, was up 14 percent compared to the prior corresponding period to 569.1 MMmt.

Copper in concentrate production at BHP’s Escondida mine in Chile increased by 70 percent year over year due to a transition to higher-grade ore feed and the successful completion of maintenance programs that have increased concentrator throughput. The average copper grade mined during the December 2012 quarter increased to 1.39 percent.

Total Escondida copper production is on track to increase by 20 percent in fiscal 2013.

Record production at the Antamina mine in Peru for the six months to Dec. 31, 2012, also contributed to the 14 percent boost in output over the prior corresponding period.

Management also reported a 26 percent reduction in copper production at Olympic Dam in Australia due to a planned smelter outage. The Olympic Dam smelter should return to full capacity by March 31, 2013.

Coking coal production was down 1 percent from the previous quarter at 8.89 MMmt, as a recovery in production after the resolution of industrial disputes in Queensland was offset by planned maintenance outages and the closure of the high-cost Gregory mine. Output was flat on a year-over-year basis.

Management expects to report a significant decline in operating costs for its coking coal assets in the second half of fiscal 2013 on higher productivity, broader economies of scale and the shutdown of higher-cost capacity.

Thermal coal output of 18.3 MMmt was down 7 percent sequentially but was up 7 percent annually to 37.9 MMmt.

BHP’s Western Australia Iron Ore (WAIO) unit posted a 12th straight year of half-year production and sales records, as “the business continued to benefit from [a] decade-long investment in supply chain capacity.”

Iron ore output was up 6 percent quarter over quarter to 42.2 MMmt and 2 percent year over year to 81.9 MMmt.

Operations in the Pilbara region were boosted by the receipt of first ore at the recently installed fifth car dumper at Finucane Island. This is the last major piece of infrastructure required to increase WAIO port capacity from the fiscal 2013 second-quarter run-rate of 188 MMmt per annum to 220 MMmt.

The Jimblebar Mine Expansion remains on schedule for first production during the third quarter of fiscal 2014. Management forecast a 5 percent production increase from WAIO in fiscal 2013 to 183 MMmt and expects “progressive debottlenecking of the supply chain” to support “substantial low-cost, longer-term growth” for the iron ore business.

BHP posted record alumina production for the quarter and the half year, while aluminum metal production increased by 10 percent year over year. Nickel production declined by 6 percent sequentially. According to management’s statement, “The strong Australian dollar and weak pricing environment continued to place pressure on…Australian alumina and nickel operations.”

Management noted at the outset of its quarterly production report that increased capacity “at a number of our highest margin businesses and strong growth across our broader portfolio is expected to deliver a compound annual growth rate of 10 percent in copper equivalent terms over the two years to the end of the 2014 financial year.”

The Roundup

Here’s other news of note from around the AE Portfolio.

Australia & New Zealand Banking Group Ltd (ASX: ANZ, OTC: ANEWF, ADR: ANZBY) opened a branch in Hangzhou, the capital and the largest city of Zhejiang Province in Eastern China, continuing to execute on its “super-regional” strategy.

ANZ CEO Mike Smith noted, “As one of China’s most vibrant and prosperous cities, Hangzhou is an important contributor to economic growth and development of the Yangtze River Delta which is a strategic market for ANZ in China.”

Zhejiang Province is home to numerous private business and Asian companies, and its increasing connections with Australia and New Zealand make it a natural location for the bank’s long-term expansion plan.

ANZ Hangzhou branch will cover the entire Zhejiang Province and offer a full range of products and services, including trade and supply chain, cash management, markets and relationship banking services for corporate customers as well as deposits, mortgages, wealth management and migrant banking services for individual customers.

A key city of the Yangtze River Delta, Hangzhou is known for its private business and personal wealth. The city hosts a large manufacturing base and information technology industry and serves as the trade and logistics hub for China’s East Coast. The economy in Hangzhou has grown rapidly, with double-digit annual GDP growth rate over the past two decades.

ANZ, which has had a presence in China since 1986, is the only Australian bank to be incorporated in the Middle Kingdom. ANZ now has branches in Shanghai, Beijing, Guangzhou, Chongqing and Hangzhou, a 100 percent ANZ-owned rural bank in Liangping County, the Chongqing Liangping ANZ Rural Bank Co Ltd, an operations hub in Chengdu and strategic partnerships with Shanghai Rural Commercial Bank and Bank of Tianjin.

Mr. Smith, during a speech in Shanghai last week, called for the Australian government to negotiate a formal agreement to foster closer business and trade ties with China and establish an overarching relationship with the world’s second-largest economy, similar to the Friendship and Cooperation Treaty established with Japan in 1976.

China surpassed Japan in 2007 to become Australia’s largest trading partner, with bilateral trade between the Middle Kingdom and the Land Down Under now worth about AUD115 billion a year.

Mr. Smith posited that an Australia-China treaty, apart from and broader than a free trade agreement now under consideration, would boost economic ties between the two countries. “Such a framework,” he said to the Australian Chamber of Commerce, gathered in China, “could focus on some key principles for our relationship with China. “There could be, for example, assurance around market access, on reliability of supply and on equality of treatment.

“If the economic relationship with China were to be articulated in a formal comprehensive set of understandings, Australia could also revive the strong sense of shared interests that would enable our relationship to weather the inevitable short-term issues.”

Australia & New Zealand Banking Group is a buy under USD24.

WorleyParsons Ltd (ASX: WOR, OTC: WYGPF, ADR: WYGPY) has been awarded a three-year contract by Royal Dutch Shell Plc (London: RDSA, NYSE: RDS/A) unit Shell Gas Iraq BV to provide project management support and services for the rehabilitation of gas facilities and infrastructure for Basrah Gas Company (BGC), the world’s largest flares reduction company.

BGC, a 25-year joint venture with state-run South Gas Company (51 percent), Shell (44 percent) and Japan’s Mitsubishi Corp (Japan: 8058, OTC: MSBHF, ADR: MSBHY, 5 percent), is expected to commence operations in early 2014. The venture’s goal is to capture, treat and monetize associated gas currently being flared from three southern oilfields, wasting more than USD10 million per day.

WorleyParsons will provide project management, technical and construction supervision personnel to support BGC in the rehabilitation inspection, engineering, procurement and construction (EPC) activities.

WorleyParsons will also provide an established project management system to help manage and control the project from plant inspections through to engineering and design and concluding with commissioning.

The contract will be executed from WorleyParsons’ offices in Iraq and the United Arab Emirates. The work for WorleyParsons over the life of the contract is estimated to exceed 500,000 man-hours.

WorleyParsons is a buy under USD30.

Here are dates for the next round of reporting season, which for most companies will be for the first half of fiscal 2013. We’ve noted where the reporting period differs.

Please consult the Portfolio tables at www.AussieEdge.com for current advice.

Conservative Holdings

  • Aberdeen Asia-Pacific Income Fund (NYSE: FAX)–N/A (fund, reports holdings on a quarterly basis)
  • AGL Energy Ltd (ASX: AGK, OTC: AGLNF, ADR: AGLNY)–Feb. 27, 2013 (confirmed)
  • APA Group (ASX: APA, OTC: APAJF)–Feb. 20, 2013 (confirmed)
  • Australand Property Group Ltd (ASX: ALZ, OTC: AUAOF)–Feb. 7, 2013 (full year 2012, confirmed)
  • Australia & New Zealand Banking Group Ltd (ASX: ANZ, OTC: ANEWF, ADR: ANZBY)–Feb. 15, 2013 (fiscal 2013 second quarter trading update, confirmed)
  • Cardno Ltd (ASX: CDD, OTC: COLDF)–Feb. 14, 2013 (estimate)
  • CSL Ltd (ASX: CSL, OTC: CMXHF, ADR: CMXHY)–Feb. 13, 2013 (confirmed)
  • Envestra Ltd (ASX: ENV, OTC: EVSRF)–Feb. 21, 2013 (confirmed)
  • M2 Telecommunications Group Ltd (ASX: MTU, OTC: MTCZF)–Feb. 27, 2013 (estimate)
  • Ramsay Health Care Ltd (ASX: RHC, OTC: RMSUF)–Feb. 25, 2013 (estimate)
  • SMS Management & Technology Ltd (ASX: SMX, OTC: SMSUF)–Feb. 20, 2013 (confirmed)
  • Telstra Corp Ltd (ASX: TLS, OTC: TTRAF, ADR: TLSYY)–Feb. 7, 2013 (confirmed)
  • Transurban Group (ASX: TCL, OTC: TRAUF)–Feb. 5, 2013 (confirmed)
  • Wesfarmers Ltd (ASX: WES, OTC: WFAFF, ADR: WFAFY)–Feb. 14, 2013 (confirmed)

Aggressive Holdings

  • Amalgamated Holdings Ltd (ASX: AHD, OTC: None)–Feb. 25, 2013 (estimate)
  • BHP Billiton Ltd (ASX: BHP, NYSE: BHP)–Feb. 20, 2013 (confirmed)
  • GrainCorp Ltd (ASX: GNC, OTC: GRCLF)–May 21, 2013 (estimate)
  • Mineral Resources Ltd (ASX: MIN, OTC: MALRF)–Feb. 18, 2013 (estimate)
  • Newcrest Mining Ltd (ASX: NCM, OTC: NCMGF, ADR: NCMGY)–Feb. 8, 2013 (confirmed)
  • New Hope Corp Ltd (ASX: NHC, OTC: NHPEF)–Mar. 26, 2013 (estimate)
  • Oil Search Ltd (ASX: OSH, OTC: OISHF, ADR: OISHY)–Feb. 26, 2013 (full year 2012, confirmed)
  • Origin Energy Ltd (ASX: ORG, OTC: OGFGF, ADR: OGFGY)–Feb. 21, 2013 (confirmed)
  • Rio Tinto Ltd (ASX: RIO, NYSE: RIO)–Feb. 24, 2012 (full year 2012, confirmed)
  • WorleyParsons Ltd (ASX: WOR, OTC: WYGPF, ADR: WYGPY)–Feb. 13, 2013 (confirmed)
Following are links to our discussion and analysis of the most recently announced financial and operating results for Portfolio Holdings.

Conservative Holdings

Aggressive Holdings

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