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Can BHP Billiton Shift to a Cash Generation Phase in Copper Soon?

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Significant cost reduction

Copper is one of the four key pillars for BHP Billiton (BHP) (BBL). It contributes to 23% of group production and 24% of underlying EBIT (earnings before interest and tax).

During the company’s copper tour on December 1, 2015, BHP’s president of copper Danny Malchuk said that despite grade decline and increasing input costs, Escondida’s use of three-concentrator strategy will leverage its latent capacity to sustain its favorable position on the cost curve. The Spence and Olympic Dam facilities are also expected to deliver improved cost structures over much longer periods.

Due to a number of productivity improvements, the company is expecting its fiscal 2017 unit cash costs to fall to $1.08 per pound. This will be equivalent to a reduction of 34% from fiscal 2012.

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Production pipeline strong

The company also mentioned that it has strong organic growth opportunities in copper:

  • Spence growth option: The company is in the final stages of studying the development of the 2 billion ton plus hypogene resource, which can extend its mine life by more than 50 years. Board review for final approval is expected within the next 18 months, with the potential to deliver first production in fiscal 2020.
  • Olympic Dam: At Olympic Dam, the company has a long-term plan to double capacity.

Price outlook favorable?

BHP commented that while near-term oversupply is weighing on prices, it expects the fundamentals to support higher long-term copper prices. This will be possible due to a structural supply deficit caused by declining grades at current operations, Greenfield projects being restricted by geopolitical challenges and social tensions, and insufficient high-quality discoveries.

In fiscal 2017, BHP expects capex at Escondida to fall below $400 million from an average of $1.7 billion over the fiscal 2012 to fiscal 2016 period. The company also expects to generate ~$1 billion in supply savings by fiscal 2017, with 45% achieved as of October 31, 2015.

Falling capex and falling costs and savings could lead to positive free cash flow from this division going forward, given copper prices don’t go much lower than their current spot rates.

While many copper producers such as Freeport-McMoRan (FCX), Glencore (GLNCY), and Anglo American (AAUKY) are cutting back on production, BHP and Rio Tinto (RIO) are continuing with their copper production expansion plans to take advantage of their relatively low-cost positions to increase their market share.

Investors who want to avoid the hassles of picking individual stocks can consider the SPDR S&P Metals and Mining ETF (XME) to get exposure to the metals and mining sector. Currently, Freeport-McMoRan forms 3.6% of XME’s portfolio.

Falling oil and gas prices have put additional strain on BHP as compared to its peers, who don’t have exposure to petroleum. In the next part of this series, we’ll see how the pressure on energy prices could translate into impairments and capex cuts at BHP.

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