While it might appear odd to say that a company that has just expanded its capital management program by $5.8 billion, increased its dividends and announced plans to spend more than $US80 billion expanding production is keeping its powder dry, that is a conclusion one could draw from the remarkable result BHP Billiton produced today.

BHP Billiton produced a record $US14.5 billion profit, up 59.2%, with record margins (an underlying overall earnings before interest and tax margin of 46%), a record on capital of 48% and near-record net operating cash flow of $US12.2 billion.

That’s despite the hiatus in production well drilling in the Gulf of Mexico as a result of the Deepwater Horizon disaster (which BHP Billiton says cost it $US464 million as a result of lost volume), the disruption to its Queensland coal operations caused by floods and an effective increase in costs of more than $US1 billion as a result of the weak US dollar.

The most striking aspect of BHP Billiton’s result is that, as a consequence of those surging cash flows, and despite reinvesting more than $US5.6 billion in its business during the half, BHP Billiton is now sitting on $US16.1 billion of cash. Its balance sheet contains no net debt — it has about $US200 million of net cash.

Marius Kloppers talked down the prospect of another attempt at a major acquisition by saying there were very few targets that met BHP Billiton’s tier one criteria and that the owners of those few that did tended, in the current environment, to have an inflated view of what their assets were worth.

Even with the continued ramping up of BHP Billiton’s capital expenditure — at the moment it has about $US11 billion of projects under development but the plan to spend more than $US80 billion from this year until 2015 implies a very significant acceleration in its spending — if it continues to generate the cash flows it is capable of generating while commodity prices remain at current levels, BHP Billiton would have a massive amount of balance sheet capacity.

The expansion of its capital management from $US4.2 billion to $US10 billion is somewhat more aggressive than it appears, given that it is scheduled to be completed by the end of this year. Rival Rio Tinto’s $US5 billion buy-back program is, by comparison, spread over two years. BHP also continues to ratchet up its dividends, with the 46 US cents a share interim dividend absorbing $US2.6 billion.

Even if all its financial settings remained static for the next five years, however — which they won’t, given the continuous pipeline of new projects that will be brought into operation over the period — BHP Billiton would still probably have about $US10 billion of extra net cash at bank in 2015 if it doesn’t continue to buy back large slabs of its capital or make a major acquisition.

Kloppers made the point this morning that those expecting a supply-side response to the high commodity prices to kick in and undermine those prices are probably underestimating the impact of the financial crisis on the capital expenditure programs of its rivals. BHP Billiton was the only major miner to continue to invest heavily, indeed to expand its investment program, during the worst of the crisis.

If he is right, it could take another couple of years, if not longer, before the anticipated flood of new production materially impacts the markets for the commodities BHP Billiton produces.

To provide some perspective on the embarrassment of riches Kloppers faces if the boom in commodity prices does persist over the next few years, it is worth noting BHP Billiton has returned, through dividends and buy-backs, almost $US30 billion to its shareholders over the past five years — and still emerged with a balance sheet that has no net debt.

The amounts of cash BHP Billiton does generate over the next few years is, of course, dependent on commodity prices and a continuation of the growth in the Chinese and Indian economies in particular, although the slowly improving condition of the developed economies will also be helpful. In the latest half the impact of higher prices alone, at $US8.5 billion, matched the earnings BHP Billiton generated in the previous corresponding half.

There are some pressures — the weak US dollar and rising input costs, particular for labour — but the unique strength of BHP Billiton’s diversified portfolio of resources, and the consistently strong cash flows and margins that portfolio generates, provides a lot of headroom to absorb them as well as a lot of insulation against volatility in particular commodity prices.

*This article was originally published on Business Spectator

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Peter Fray
Peter Fray
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