Nicholas Grove: In the not-too-distant future Rio Tinto and BHP Billiton will release their earnings results; Rio Tinto for the first half of calendar 2012 and BHP Billiton for the full year to the end June. Here to discuss what to expect from the big two miners, I am joined by Morningstar's Mark Taylor.
Mark, thanks very much for joining us.
Mark Taylor: Thanks, Nick.
Grove: First of all, Mark, in a recent report you said your earnings estimates for the two companies were broadly in line with those of the market, except for BHP where you said your earnings estimates had some “whiskers” and were slightly above consensus. What do you put this down to?
Taylor: Well, BHP in the recent past made major shale gas acquisitions in the U.S. including Petrohawk, and those acquisitions are of a magnitude that have increased the petroleum division's contribution to earnings to around about a quarter for the whole group. So, oil and gas is now very important to BHP.
The U.S. gas price has been very low, so the market has been discounting the contribution from those shale gas assets in the U.S. We have a more sanguine view of how that's going to pan out. So, we've probably credited BHP with solid earnings from the oil portion of those shale gas assets more so than the market probably has so. We're just a little bit more optimistic about the outlook for those shale gas assets and that is an area that we could be proven to be wrong in the fullness of time. Time will tell.
Grove: Mark, you described your earnings forecasts for Rio Tinto as aggressive. What's behind this outlook?
Taylor: Well key, I suppose, is our outlook for the aluminium industry. It's well-known that Rio made a very large acquisition a number of years ago: $40 billion for Alcan. That's been a huge weight on their earnings ever since with the aluminium market very depressed. We think a key reason for the depression in the aluminium market has been Chinese oversupply of aluminium, almost deliberately to suppress the price of a key import alumina.
Historically, the industries had this link between alumina and aluminium prices, and Chinese companies have taken advantage of that. We think that has just about played out. Alumina prices are being delinked from aluminium, so we see profits moving again upstream to players like Rio, which have bauxite and alumina assets, not just the downstream smelting assets. So that migration of profits, that’s what we're expecting to see in Rio's earnings and we may be a little bit premature on that front, but once again time will tell.
Grove: Also, Mark, in your report you discussed where the two companies earnings sensitivities to certain commodities lie; broadly speaking, which company has the more risky set of sensitivities and conversely which company has the more beneficial?
Taylor: I mean, it's a difficult question to answer, because you can say for BHP that it's a far more diversified company, so on balance, over time its earnings stream should be smoother, because when one commodity is doing well and other is perhaps not doing as well and they offset each other. But there is also that expression diversification. If you are diversified into all the worst commodities, then it doesn’t really help you.
But on balance we think BHP is more diversified asset portfolio is going to hold it in better state. Rio has very aggressively gone into iron ore to the point where in the last half of the year iron ore contributed 85% of its earnings, which is fine while the iron ore prices is going gangbusters. But when the inevitable happens and it falls, that potentially leaves Rio very exposed on the earnings front.
Grove: Finally Mark, 1st of July sees the government's mineral resources rent tax and carbon tax come into effect, will your earnings estimates for the big two remain unaffected by this?
Taylor: Yes. The carbon tax we see is only a minor issue for them in terms of costs and so on. The mineral resources rent tax, obviously, much larger impact but we have had those impacts baked into our forecasts for a long time now. So, there won’t be any change to earnings forecast when they are formally introduced.
Grove: Mark, thanks very much for joining us.
Taylor: Thanks, Nick.
Grove: To read Mark’s recent special report on BHP and Rio Tinto, Morningstar.com.au premium subscribers can go to the 'Special Reports' tab and click on the link below.
