Commodities

David Fickling is a Bloomberg Gadfly columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.

The simmering battle between Paul Singer's Elliott Management Corp. and BHP Billiton Ltd. seems to be edging toward a truce.

With the shares finally trading above the levels they reached when Elliott first disclosed its stakes in the dual-listed company back in April, there's a new tone of comity. "BHP appears to have taken steps toward a smarter, more value-generative way of conducting business" following the election of Ken MacKenzie as chairman, the investment firm said last week in announcing it had taken its shareholding above 5 percent.

Swings and Roundabouts
Shares in BHP have only just moved above their levels at the time Elliott disclosed its investment
Source: Bloomberg
Note: Normalised. April 7, 2017 = 100. Elliott stake was revealed on April 10, 2017.

BHP's five-fold jump in full-year underlying profit reported Tuesday will only enhance those warm and fuzzy feelings. In addition to the $6.7 billion headline figure -- actually a tad lower than analysts were expecting -- there was a promise to exit its U.S. shale assets, one of Elliott's original key requests.

BHP has been quietly sidling away from that business for several months, but the black-and-white commitment, combined with MacKenzie's elevation, represents a minor coup for Elliott. At the same time, this has in some ways been a phony war: For all the high principles of Elliott's activist campaign, buying stocks in mining companies is more a matter of getting a ticket to the commodities casino than anything to do with shareholder value as conventionally understood. 

Place Your Bets
The variance in BHP Billiton's earnings is almost entirely a result of commodity price shifts
Source: Company reports, Gadfly calculations
Note: Figures are for variance of underlying Ebit in 2014 and 2015, and underlying Ebitda in 2016 and 2017.

Have a look, for instance, at the earnings waterfall charts that BHP typically includes with its annual results, showing what contributed most to the variance in profits. The things that executives try to affect to improve shareholder value -- in particular, increasing sales volumes and reducing costs -- are overwhelmed by the one giant swing factor: commodity prices. The biggest driver of a mining company's market value is entirely outside of management's control.

On the other issues where Elliott was pressing for change, there's little sign of movement. An extra 10 cents was added to the dividend, but that brought the annual payout ratio to the 75 percent that BHP's rival Rio Tinto Group is meeting without any prompting from activists.

The commitment to keep capital spending below $8 billion in the 2019 and 2020 fiscal years also fits the Elliott playbook, but it's been 18 months or so since analysts were forecasting a bill larger than that for those years. In addition, Chief Executive Officer Andrew Mackenzie can expect additional headroom for budget items such as the $2.46 billion Spence copper project signed off last week, once the capital-intensive U.S. shale business goes.

Belt Tightening
It's been 18 months since analysts expected BHP to spend more than $8 billion in capex in 2019 and 2020
Source: Bloomberg
Note: Based on median of analyst estimates compiled by Bloomberg.

As for the request to unify BHP's dual listing -- still one of the core planks of Elliott's plan -- there was no mention in Tuesday's announcements.

There's an important lesson here for investing in mining: The average cost of BHP's key product, iron ore, was 35 percent higher in the 12 months through June than in the previous fiscal year. No industrial or consumer company could count on such revenue fluctuations to bail it out of a tight spot -- and none, on the flip side, runs the risk that negative moves on such a scale could plunge it into losses.

Elliott's success with BHP will be guided not by its ability to unlock hidden sources of value, but by its fortune in timing commodities markets. Mining companies aren't General Electric Co.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
David Fickling in Sydney at dfickling@bloomberg.net

To contact the editor responsible for this story:
Paul Sillitoe at psillitoe@bloomberg.net