Why BHP is letting internal projects compete for capital

Market Realist

Must-know: An investor’s guide to BHP (Part 9 of 10)

(Continued from Part 8)

BHP’s internal projects

BHP’s management is focused on the internal rate of return (or IRR) of greater than 20%. IRR is the rate of return at which the net present value of all the cash flows from a project is equal to zero—the higher the project’s IRR, the more desirable it is to undertake the project.

Projects within BHP are competing for capital. Only the ones with highest return options, those that fall above the hurdle rate, would be considered for development. As a result, each segment within BHP is trying to minimize costs and maximize productivity in order to fall over that hurdle rate.

The previous chart shows that, with absolute capital spend decreasing, internal projects will now have to compete with each other. They’ll have to offer more value to get selected for development.

Constantly evolving portfolio

BHP has evolved its investment in different assets over time as the dynamics and economics for different commodities have changed. Over the last five years, BHP has shifted its investment towards high-margin iron ore, copper, and petroleum projects.

Productivity measures and their impact

  • Petroleum–  BHP had benchmarked the fastest drilling times for individual well segments. This reduced the days of drill time by ~35%.
  • Coal – At Queensland coal mines, the truck fleet in the pre-strip operations was the bottleneck. Over the past 18–24 months, BHP’s teams worked there through less downtime on shift change , input refueling, and better planning. This increased the truck performance by 40%.
  • Iron ore – At western Australia iron ore, the bottleneck was at the mines. By increasing throughput and improving reliability, overall performance of the mines’  ore-handling plants has improved by 4%.

At the group level, the productivity measures reflect in the return on capital employed. It improved to 22%.

BHP Billiton (BHP) has made good progress on increasing returns and enhancing margins through productivity and cost control measures. BHP was significantly investing in capex for a decade.

However,  for the last two years its focus has shifted to cost cutting, increasing productivity, and returning cash to shareholders. This policy shift is in the wake of declining commodity prices. It will keep mining companies across the board looking for the opportunity to optimize their portfolios.

BHP’s peers, like Rio Tinto (RIO), Vale SA (VALE), and Cliffs Natural Resources (CLF), are experiencing similar situations. Exchange-traded funds (or ETFs), like the SPDR S&P Metals & Mining ETF (XME), also give exposure to the metals and mining sector.

Continue to Part 10

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