BHP in race between cost-cutting, commodity prices

LAUNCESTON, Australia, Feb 25 (Reuters) - The jump in BHP Billiton’s shares after profits plunged shows a mindset akin to buying tickets for the Titanic’s second voyage because the gash in the hull from striking the iceberg isn’t as bad as feared.
BHP’s Australian-listed stock jumped almost 3 percent on Tuesday to close at A$33.06, and extended gains to A$33.54 in early trade in Sydney on Wednesday, a three-month high.
The world’s biggest mining company posted a 31-percent drop in half-year underlying attributable profits to $5.35 billion, but this was ahead of the consensus forecast of $5.1 billion.
An increase in the interim dividend to $0.62 a share was also ahead of market forecasts, and this goes a long way to explaining the boost in the share price.
But delve deeper into BHP’s results for the half-year ended Dec. 31 and the impact of the rout in commodity prices becomes more apparent, as does the prospect of even lower profits in coming reporting periods.
Even Chief Executive Andrew Mackenzie adopted a sombre tone, telling a call with analysts that the price of iron ore, the miner’s main commodity, was likely to remain under downward pressure as more supply comes to market.
“Although we see some loss of production, particularly from expensive Chinese iron ore (producers) ... we still see a growing surplus of low-cost supply and therefore, if anything, the pressure on the price is (still) downward,” he said.
It’s not just iron ore, which makes up half of BHP’s profits, that is under pressure, with crude, coal and copper prices also struggling as available supply outweighs demand.
It’s somewhat ironic that the best performing parts of BHP are the ones the company intends to spin off into a new company, to be called South 32. These include aluminium and manganese.
Going back to the positive market reaction to the BHP results, and it becomes clear that for this to be a sustained rally, investors will have to believe that the miner will be able to cut costs at faster pace than it loses revenue from lower commodity prices.
BHP, along with its main competitor Rio Tinto, has had great success in cutting costs, and said in its presentation on Tuesday that it’s on track to meet its target of $4 billion of productivity gains by the 2017 fiscal year.
Lower exploration spending will also help free up cash flow that can be used to meet the promise of higher dividends.
But the company was also quite clear that cost savings get harder to find and the process can’t go on indefinitely. However, commodity prices may not play ball, and further declines will hit revenues.