The Motley Fool

Why resources companies have let investors down

Investors invest in shares for two reasons. Capital growth and or regular dividends.

That’s something that resources companies have failed to remember to their detriment. Despite a massive bull market over the past decade or so, the share prices of Australia’s leading resources companies are substantially below where they were five years ago.

Even looking at the period from March 2009 coming out of the GFC, the S&P / ASX 200 Index (Index:^AXJO) (ASX:XJO) has risen 45%, but Rio Tinto Limited’s (ASX:RIO) shares are up just 5%, BHP Billiton’s (ASX:BHP) up a marginally better 7%, while Newcrest Mining (ASX:NCM) shares are down a massive 55%.

Resources companies are not traditionally big dividend payers, so investors would mostly invest in the big miners for capital growth. Unfortunately, that hasn’t been forthcoming, and there’s growing unrest amongst investors.

Newcrest destroyed shareholder value by taking over Lihir Gold at a cost of $9.5 billion, with projections of combined production now looking farcical.

At the time, Lihir chairman Ross Garnaut said “Through joining with Newcrest, we can immediately deliver strong returns to our shareholders with certainty, while simultaneously achieving greater diversification, reducing costs and improving our risk profile.” Lihir shareholders may not be feeling the joy.

Rio Tinto did its shareholders the same disservice with its purchase of Canadian aluminium producer Alcan for US$38.1 billion in 2007, and has subsequently been forced to write off at least half of that. BHP isn’t in the clear either, forced to write down its US shale gas by US$2.8 billion in 2012, as well as abandoning several mega-projects.

The problem with investing in resource companies is that they are highly capital intensive – one of the reasons why they don’t pay high dividends. Funds are instead retained and plowed back into the business to replace lost resources through exploration, drilling and expansion of existing mines, or acquisitions of resources.

That is a never-ending cycle, and unless resources companies can generate a higher rate of return after expansionary capital expenditure is included as a cost, a cynical observer might suggest that investing in resources companies is a loser’s game.

Foolish takeaway

And so far it has proved to be exactly that, with share prices virtually unmoved or down, and investors not compensated through higher dividends. Management of resources companies need to regain their investors’ faith, but it won’t be easy in the face of falling commodity prices.

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Motley Fool writer/analyst Mike King owns shares in BHP.

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