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Why BHP’s (ASX:BHP) $12bn profit is not enough

Yesterday after market, BHP(ASX:BHP), the world’s largest mining company posted a whopping $12bn in full year profits. But this is the second lower profit announcement from the group.

BHP BillitonThe major factor behind this is cited as being the decline in global commodity prices. Iron ore had tumbled to sub $100/tonne in September of last year. Before recovering strongly. This kind of drop in price certainly impacts significantly on the mining sector – obviously through falling revenue but given the significant lead time in developing new production facilities and the costs associated with them.

Costs and their impact

Cost pressures are also a major obstacle for the sector. BHP has worked hard in cutting costs – shaving a lazy $2.7bn over the last year. However, costs within the sector remain high, based on virtually any measure.

I was having lunch with a friend last week, who had previously worked in the chart yacht business for many years. One of his former colleagues is now working on an iron ore barge in Port Headland – not quite as pleasant as floating around the Caribbean or the Mediterranean on a gin palace, although the $200k plus a year he is now being paid, may well be a sufficient offset. Equally, in the Bowen basin, a kitchen hand can expect $85,000 pa – a massive skew from what is remotely commercial.

Labour costs represent only a tiny fraction of overall expenses facing the giant miners. The company is pumping a further $2.6bn into its Jansen potash business in Canada. The numbers are massive – reflecting the scale of the businesses and developments required.

What next for the hills?

In terms of the current state of play for BHP, the slightly lower dividend is of no concern – after all, investors are looking for growth rather than income, at least in terms of the company’s dividend policy. Based on the current pullback in the stock, we are looking for opportunities to re-enter, with the goal of continuing to generate income through selling calls.

The key thing to consider here is a simple one. It is not so much about the stock, it’s about extracting cash flow from the stock, and whether the longer term outlook for BHP is strong or weak, there is income to be made through selling calls right now.

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