Australian investors are well and truly back in love with their biggest miners, less than 12 months after they slashed their dividends and earnings and faced criticism from the ratings agencies.
In a week that saw Rio Tinto sell its Hunter Valley coal operations for $3.2 billion, and BHP Billiton deliver a strong set of fourth quarter production numbers, the share prices of these two giants rose 9 per cent and 4 per cent respectively. That continues a run that has seen them jump 13 per cent and 10 per cent since the start of 2017.
Indeed, as the Trump bump has rippled through global markets it has been Rio and BHP that have been two of the big drivers of the 8 per cent gain the ASX has enjoyed during the last three months. The big banks have also been important in the rise.
Those dark days of early 2016, when cratering commodity prices saw Rio and then BHP kill off their progressive dividends – which essentially guaranteed shareholders that their payouts wouldn't go backwards – seem like a distant memory.
Rio is up 78 per cent in the last 12 months, with BHP up 83 per cent. As one analyst asked this week: what on earth were the ratings agencies so worried about?
To be fair, the big miners were carrying too much debt to sustain their big payout promises, and no-one in the ratings agencies – or really in the entire sector – foresaw China's decision to curtail production at its local coal mines, a move designed to reduce oversupply and pollution.
The Chinese shift boosted coal and then iron ore pricing in a way the big miners would have only dreamt about. Now, with coal prices riding high and iron ore sitting at $US83 a tonne – compared with $US39 this time last year – BHP and Rio find themselves throwing off more cash than anyone could have hoped for.
But now the market is asking: how will this cash be used?
There are three main options: further strengthen balance sheets by paying down more debt; increase spending (either on existing projects or new deals); or lift shareholder returns.
Not surprisingly, the push for option three has already started. But investors shouldn't hold their breath for Rio chair Jan du Plessis and BHP's Jac Nasser to launch a major cash splash at their February results announcements.
Soon after Rio released its quarterly report on January 16, analysts began tipping higher dividends and/or a share buyback. The mining giant's sale of Coal & Allied in the Hunter has only increased that push. While Rio said the deal "will reduce the net indebtedness" of the company, its gearing is now firmly below its 20 per cent to 40 per cent target.
Citi is expecting Rio to launch a $3 billion capital management program at its results. "This sale likely opens up increased opportunity of potential shareholder returns," the broker said this week following the coal deal.
Under its new dividend policy, Rio will pay 40 per cent to 60 per cent of its underlying earnings "in aggregate through the cycle". It has guaranteed its shareholders will receive at least $US1.10 per share for the 2016 calendar year.
Shareholders are likely to do a bit better than that, but not much. While Rio does have its debt under control, it has several growth projects underway (particularly the Amrun bauxite project in Queensland and the Silvergrass iron ore mine in Western Australia) and its iron ore operations still chew up about $2 billion of sustaining capital a year.
Median market consensus for Rio is for $US1.39 a share, while UBS mining analyst Glyn Lawcock expects $US1.40 a share at the full year results next month and Credit Suisse is looking for a dividend of $US1.50. That would still be well down on last year's payout of $US2.15 a share.
While BHP wrestled long and hard with the decision to abandon its progressive dividend policy, the clear feeling coming out of its Collins Street headquarters is balance sheet first, capital returns second.
That's a position that has the full backing of a number of shareholders, including Australian Foundation Investment Company chief executive Ross Barker, who owns $350 million of BHP shares and $218 million of Rio stock.
"We're always about good balance sheets," Mr Barker said this week, noting that the gyrations in the iron ore price in the last 12 months underline why caution is needed. Who would want to bet that iron ore prices hold at $US80 a tonne, or even the $US55 a tonne BHP and Rio enjoyed in the December quarter of 2016?
Certainly not BHP and Rio. They have been consistent in their caution that higher iron ore and coal prices are unlikely to persist. While that doesn't mean the miners are expecting a retreat to the lows seen in late 2015 and early 2016, it does mean they will remain careful about allocating any capital that doesn't strengthen their businesses in some way.
The dividends outlook should brighten towards the end of 2017, depending on where commodity prices head. Analysts expect Rio's debt levels will low enough by then (Credit Suisse expects gearing will be sitting at 10 per cent) for dividends to rise to above $US2 a share.
BHP's dividend trajectory is seen as a little less steep, forecast to rise from US30c for the 2016 financial year to US77c a share for 2017 and US88c in 2018. But that reflects the predicted increase in its earnings (it pays up 50 per cent of earnings under its new dividend policy) rather than specific capital management.
Oh, and when it does come time for the likes of BHP and Rio to reward their loyal shareholders, Barker is clear that he favours higher dividends over buybacks. However, this view is not necessarily shared by the big miners' British shareholders, and there will be some debate over whether buybacks and higher dividends should be favoured.
One thing we can forget is the big two making acquisitions. The fire sale that many hoped would eventuate last year in resources never even got started, and management at all of our big miners are painfully aware of the sector's terrible track record when it comes to buying other miners and even specific assets.
As one executive said recently, the miners could actually re-rated by some investors if they can keep their cheque books shut.
Macmahon fights back
Very few takeover targets of CIMIC evade the clutches of the Spanish-backed juggernaut, but the independent directors of Macmahon Holdings have shown they are going to put up a fight.
In a strongly worded statement released on Friday, the directors declared Macmahon's 14.5¢ share a bid does not represent "fair value" and advised investors to take no action.
Macmahon badly needs to halt the flow of retail shareholders who have already started selling into the CIMIC offer. The directors need to buy time to mount their defence and push for a higher offer.
In Friday's statement the directors mounted the argument that CIMIC knows only too well how opportunistic its offer is. CIMIC "would be well aware of the improving market conditions and of Macmahon's progress with some opportunities in which Macmahon and Thiess are in direct competition," the statement says.
Expect Macmahon to announce some contract wins in the coming weeks to ram home the point that CIMIC is making its bid just as the cycle turns, and long-suffering shareholders should hold on to see if the board can't eek a better price out of the Spanish.
CIMIC is likely to employ its usual tactic of saying very little to the target or the media. That worked in the takeover bids it launched for Leighton Holdings, UGL and Sedgman, but it appears Macmahon's directors won't go quietly.
