BHP & RIO BET THEIR FUTURES ON CHINA

JUST like BHP, Rio Tinto will be returning every dollar it clears from its consolidating asset sales to shareholders. It is also paying 50 per cent of its profit in dividends; BHP will presumably do something similar. Good.

Just like BHP, Rio Tinto will, though, “get back to shareholders” on just exactly how it will return the money.

In both cases, the decision is essentially between dividends – franked to investors in the Aussie version of the company and unfranked to those in the UK arm – or using the franking credits in an off-market buyback of Aussie Rio (and BHP) shares.

The choices could be somewhat different because the majority of the Rio shares are in the UK arm while the opposite is the case with BHP; so maximising the use of franking credits (via a buyback) can deliver relatively more bang for the buck across the whole BHP group.

The one big difference between the two exercises is that Rio will be returning around 80¢ of every dollar it clears from its sales because it has to first pay tax on profits from them. BHP gets to return 100¢ in the dollar because it doesn’t face a tax bill as it is selling out of its US shale at a big loss.

The asset sales will make both BHP and Rio even more heavily weighted to iron ore and to Pilbara iron ore specifically.

Indeed, Rio is becoming even more an iron ore company with “boutique” copper and aluminium out shale, conventional petroleum was actually a tad more profitable than iron ore.

Notionally adjusting for the shale sale, the iron ore gross profit share kicks up to “just” (compared to Rio) 40 per cent. But if you add BHP’s met coal – its only use is with iron ore – the “steel make” contribution notionally adds to 54 per cent of BHP’s post-shale half-year profit.

In short, both BHP (54 per cent) and Rio (64 per cent) are long, and I mean long (both in revenue and even more in not just gross profit but profit-ability) China. And again, not just to “China” in some broad sense, but a China that wants to keep making a lot, and I mean a lot, of steel.

In short, whether managements and boards fully appreciate what they have done, they have actually committed the future of the two companies to three things.

First, a China that “succeeds” – that manages its transition from a “19th century, robber baron style, growth at any cost, economy” to a more consumer-friendly and services-focused economy.

Second, that it does so without abandoning its commitment to keep producing at least as much steel and concrete as it is doing today.

And third, that it also keeps building new coalfired power stations. The Chinese live in the world of reality; they ain’t going to be running their steel mills on wind or solar (occasionally) generated electricity.

Not even if it comes “with batteries included”.