BHP Billiton Is Now In The Cost Cutting Business

Australia’s big companies continue to post their bad news. We’ve given Qantas, Holden and QBE enough of a hard time the last few days, so it’s on to BHP Billiton today. The largest mining company in the world announced that it is going to make money from its US shale operations…in 2016.

They’re a patient bunch those miners. In the meantime, the strategy to generating profit growth is cost reduction and efficiency, says CEO Andrew Mackenzie. And there’s plenty of opportunity there. The company revealed US$440 million in charges related to the lack of activity in its shale gas fields recently. And that’s far from the only cash leak. The company booked a US$2.84 billion impairment on its gas projects last year, a US$100 million charge for unused rigs and $US170 million for under-used pipelines in Louisiana and Texas.

We can see what Mackenzie means when he says ‘the company’s productivity agenda has the potential to create more value than anything else we do.’ Bloody oath!

But what will the world look like without BHP’s cash splashing? We’re about to find out in the heartland of Australia’s mining boom, the Pilbara. The Australian Financial Review is pitching it like the next episode of a TV show involving Kerry Packer: ‘A new war on costs has broken out between Australia’s two largest miners with BHP Billiton chief executive Andrew Mackenzie outlining aggressive cost-efficiency expectations for the expansion of the iron ore business in Western Australia, beating Rio Tinto’s.

Or maybe it should be a reality TV show instead. We can just imagine the scene where the CEOs of Rio and BHP run around their mine sites with an axe, ‘cutting costs’. Anyway, the name of the mining game is survival these days. ‘Our cost cuts are bigger than yours.’ And that doesn’t bode well for a resource driven economy like Australia’s.

And yet, unscathed by its experiences, BHP is still on the lookout for new projects. At a Houston presentation, the company pitched a new oil opportunity in Trinidad to investors. The presentation had all the buzzwords like ‘tier one oil field’, ‘significant potential’ and a new ‘core region’ for the company. All that might’ve sounded familiar to those who heard about shale gas before the billions of dollars in write downs.

Don’t worry too much about the end of the mining boom. Housing will replace it, of course. Property is so safe these days, you can take it to the bank and your Super Fund too. Self Managed Super Fund (SMSF) administration company Heffron has picked a fight with Morgan Stanley Australia chief Steve Harker over his warnings on the boom in SMSF borrowing to invest in property. We’d be careful; Harker is a former union official.

Anyway, Heffron reckons the build-up of leverage in the SMSF sector to buy property is just fine. The proportion of Heffron administrated funds which borrowed to buy property tripled from 4% in 2011 to 12% in 2013.  Here’s a great quote from the Australian Financial Review:  ‘Of Mr Harker’s comments, financial adviser Sam Henderson said: “It’s a load of rot. There is not a lot of borrowing to buy residential property inside super. Property has always been a good investment, but like shares there is good and bad property.”’

The quibbling is amusing. But who’s right? Christopher Joye explains that it’s where this trend could be going that’s dangerous: ‘My high-level analysis of unmet housing demand in SMSF portfolio ranges from $150 billion to $450 billion.’ That’s a lot of leverage which could pile into the property market. But leverage is one of the few ways you can lose more than your initial investment. And when it comes to preparing for retirement, which is the so called ‘sole purpose’ of Super, that’s just dangerous.

Harker’s original point was that investors are using SMSFs to make additional property investments on top of owning their own home, and often an investment property as well. That can leave many overinvested in one asset class and, by virtue of property prices and the nature of property, dangerously overleveraged too. If one in a hundred SMSF property investments fails, and each failure wipes out an entire super account, it’s still a serious problem.

Meanwhile, actually finding a place to live for those looking to get started in life is falling by the wayside. First home buyers are on strike in their parent’s lounge rooms, while those same parents bid up the price of property. They chop off the bottom rungs of the property ladder to add to the top, and then complain that their kids can’t climb it.

That’s a bit harsh. It’s all the government’s fault in the end, of course. You can spot the true problem in this paragraph from the Sydney Morning Herald:

The value of loans for investors jumped 8.2 per cent for the month to reach $10.3 billion – the highest level on record. Owner-occupied loans grew by 1.7 per cent.

The lift in investor activity was a “significant step-up … worthy of further monitoring”, Westpac senior economist Matthew Hassan said, adding that the value of home loans to investors rose by an annualised pace of 47 per cent over the past six months.

Housing construction finance expanded by 1 per cent in October.

In other words, investor demand is going bananas and the housing supply isn’t budging. High demand plus restricted supply gives you rising prices. Why is supply restricted? Because the government restricts it with taxes, zoning, planning and other measures.

But there’s something else hidden in the discussion so far. First home buyers might be tumbling as a percentage of the market, but their dollar contribution is actually quite steady. Except for Kevin Rudd’s first homebuyer grant boom.


Perhaps this chart proves the property bubble theory? The first home buyers are responsibly trundling along with the same dollar commitment while everyone else is losing the plot with what they’re willing to pay. Real demand is stable, speculative demand is surging. And that means property is in a bubble.


Nick Hubble+
for The Markets and Money Australia

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Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like.

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