The good times are well and truly over for BHP Billiton (LSE: BLT) and Rio Tinto (LSE: RIO). Iron ore prices have cratered in recent months, touching a low of $45.80 a tonne at the Chinese port of Tianjin last night, the second lowest price on record since The Steel Index began tracking the spot price in November 2008.
And BHP’s troubles aren’t just limited to iron ore. The prices of all four of the company’s four ‘key pillar’ commodities are under pressure. Copper hit a new six-year low this week, coal is trading at an all-time low and the price of oil continues to plunge.
With no end to falling prices in sight, the writing is on the wall for BHP and Rio Tinto. At some point, with sales falling and margins contracting, I believe these two miners will be forced to curtail payments to shareholders, following in the footsteps of peers Glencore and Vedanta.
Value destruction
BHP and Rio aren’t exactly the most shareholder-friendly companies. While the two miners have put up a good show of returning capital to investors via dividends and buybacks, capital spending figures from City analysts tell a different story.
According to the investment bank Morgan Stanley, between 2005 and 2014 BHP, Rio and Anglo American spent a total of $246bn expanding production. The cumulative benefit to earnings before interest and tax for each company from this spending splurge was $12bn, $6bn and $1.3bn respectively. That’s a return on investment of around 7.8%.
However, the additional capacity brought on-stream by these miners has weighed on commodity prices. The markets for key commodities such as iron ore, coal and copper are now oversupplied. As a result, price declines have cost BHP, Rio and Anglo $29bn, $11bn and $8bn respectively in lost earnings during the last three years alone. Simply put, during the past decade these three miners spent $246bn to lose just under $29bn.
At the mercy of the market
By cannibalising their own revenue streams via overproduction, BHP and Rio have put themselves in a very awkward position. The two miners have no control over the prices of key commodities, so it’s not possible to predict how long the downturn will last.
Unfortunately, looking at the figures, it seems as if BHP and Rio are already struggling to scrape together the cash needed to fund their dividends to investors.
For example, the figures for BHP’s last financial year show that the company generated $19.3bn in cash from operations during the year. Capital spending for the year totalled $12.9bn, leaving $6.4bn for the dividend, which actually cost $6.5bn. Commodity prices have only deteriorated since BHP reported these figures.
Rio’s finances are not much better. During the first six months of the year, the company generated $4.4bn in cash from operations. Capital spending totalled $2.5bn and the dividend cost $2.2bn. The company spent $300m more than it could afford on payouts to investors.
This overspending by Rio and BHP can’t go on forever. Something will have to give.
