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Internal Memo Goes Public
You could almost see it coming as word of an internal memo found its way to the newswires by late morning via The Australian newspaper. The memo from Iron Ore Division president Jimmy Wilson was apparently distributed to several thousand employees. Essentially the memo was intended to make key employees aware that the industry in general is “facing numerous challenges including substantial capital and operating cost escalation and decreasing commodity prices.”
In confirming the details of the memo, a BHP spokesperson applied some top spin. “Mr. Wilson basically talked about the challenges the market is facing, and our belief in the long-term attractiveness of the iron ore market and the commitment to the projects that we currently have in execution.” Pay attention, here comes the kicker. “It is in this overall context that we are reviewing the sequence and pace of our future growth projects and our capital and operational efficiency.”
About Face
It has been just a fortnight since BHP released its latest Exploration and Development Report. It seems as though, in the interim, the company is at least considering some changes in plans. For the purpose of clarity, we’re going to eliminate the “party line” platitudes like “long-term attractiveness” and report the hard news.
The bottom line is that Mr. Wilson was warning his staff to be prepared for the possibility of “extended project development timelines.” The Australian reported that some contractors have already started laying off workers after hearing of the BHP memo. One analyst observed that “The appointment of Jimmy Wilson, possibly coupled with growing macro uncertainty, seems to have shifted the focus of BHP’s growth aspirations back towards lower risk.”
The chief focus seems to be reduction of capital expenditures relative to the expansion of Port Hedland in Western Australia, already the second largest iron ore port in the world. What was originally going to be a 200 million tonne per year expansion at an estimated cost of US$20 billion, was initially reduced by 50%. Now it appears that the project will be implemented in multiple phases. That alone is an indication that the company is unsure of both the potential of waning market conditions and of its ability to sustain the projects financially as a result of reduced cash flow. The negative impact then drives down to the share holder level with reduced dividends. Long-term aside, it is estimated that BHP will have to borrow about US$5 billion this year alone to cover shorter term requirements.
It is likely that Mr. Wilson is trying to manage within the scope of what he considers to be a high potential for lower long-term iron ore prices combined with increasing production costs. BHP CEO Marius Cloppers expects the peak Chinese demand for iron ore will have passed by 2025.
The company is also considering postponing other projects, including a US$10 billion potash project in Canada and a US$30 billion mine expansion in Australia.
BHP Billiton (LSE:BLT) at 1:43pm yesterday share price plunged to 1,864p, down 28.00p from yesterday’s close and 43.00p in 15 minutes.
