Nothing illustrates the cyclical nature of the resource and energy markets than the actions of BHP (ASX: BHP) and Rio Tinto (ASX: RIO) over the past decade.
Rio Tinto forked over a cool US$38bn (AUD$52bn) for aluminium miner and producer Alcan in November 2007, while starting in 2011 BHP spent around A$50bn entering the US shale (or tight) oil market.
These investments were made near the top of the aluminium and oil markets, respectively. The subsequent cyclical downturn in these markets led to tens of billions in losses on these investments and contributed to both companies replacing their CEOs.
The new CEOs – Rio’s Sam Walsh (and more recently JS Jacques) and BHP’s Andrew Mackenzie – have forsaken large acquisitions in favour of cost cutting and clamping down on capital expenditure to right their respective ships. BHP also spun off a bunch of smaller, non-core assets into South32 (ASX: S32).
Value over volume
And after dramatically expanding their iron ore operations over the past decade, “value over volume” has become the new mantra for the resource giants.
I can’t quibble with the South32 spinoff: it makes sense for a large miner like BHP to get rid of smaller assets that simply couldn’t compete for capital as part of the wider BHP.
But the unfortunate consequence of Rio and BHP’s top-of-the-cycle investments – and resulting high debt loads – was they couldn’t take advantage of the cyclical downturn even if they wanted to.
Contrast Australia’s big two miners with coal miner New Hope (ASX: NHC). New Hope purchased the Bengalla coal mine for around $900m in 2016, when thermal coal prices were around US$50 per metric ton.
This turned out to near the cyclical bottom in thermal coal prices, which have since rallied to over US$100 per metric ton.
While New Hope would probably admit that it wasn’t trying to pick the bottom of the cycle, importantly it was willing and able to take advantage of the downturn in the thermal coal price to invest countercyclically.
And while the $900m purchase price looked expensive at the time, this was only because investors were concentrating on then-current thermal coal prices rather than what prices might be once the cycle inevitably turned.
Purse strings loosening
However, as the mining bust has turned to a nascent boom, we are starting to see signs of the big miners loosening their purse strings.
The problem with owning depleting assets is that sooner or later you need to replace exhausted reserves.
BHP has recently approved spending US$2.9bn (A$3.8bn) on its new South Flank mine, with Pilbara competitor Fortescue last month also approving its new Eliwana iron ore mine at an estimated cost of US$1.3bn (A$1.7bn). And Rio is also likely to approve its Koodaideri iron ore mine in the near future.
Neither of the big two has yet made a material acquisition, and BHP is still trying to get rid of its unwanted US shale assets.
Ironically, it is BHP discard South32 that is leading the way in terms of expansion by acquisition, agreeing this week to pay US$1.3bn (A$1.8bn) for the 83% of Arizona Mining – a zinc and silver play in the US state of the same name – that it doesn’t yet own.
Time will tell whether Rio and BHP can maintain their new-found discipline, or resort to paying up to expand as the recovery in resources markets continues.
Either way, the contrasting actions of Australia’s two resource giants and the likes of New Hope offer a good lesson in investing in resources markets – or all cyclical markets, for that matter.