Melbourne Mining Club delivered South32 chief executive Graham Kerr a packed city town hall to help celebrate the first birthday of the BHP Billiton offspring.

Melbourne Mining Club keeps the mining torch alight in the historical capital of Australia’s mining industry. Capacity crowds have attended recent lunches hosting global industry executives as well as investor briefings from lesser known companies. Encouragingly, interest is strong.

‘People’ was a frequently recurring word in Kerr’s address about his determination to breathe new life into BHP’s abandoned assets. People had chosen the company name. “Great people” were one of the building blocks for success. People need a safe work environment. 

He had been “lucky to work with some incredible people”. People’s lives could be changed for the better by the mining industry. Kerr said he loves leading and developing people.  “Our people” wrote the company’s values, he said.

Kerr was acknowledging the important contributions of those outside the boardroom and executive suite to a sustainable business and operating culture in a nascent company. He would have also been sensitive to the impact of his plans to cut 4,500 jobs, accounting for nearly 20% of the company’s workforce, within two years.

At the outset, Kerr evidently wanted to explain why he had moved to South32 rather than stay at BHP. In taking some time to go through the reasons, he made one of only very few deviations from his prepared text. 

Kerr’s ad lib that “tweaking the sausage factory holds no appeal for me” was his summary of why he opted for South32 in preference to his old job. This was no slip of the tongue. It sounded like a pointed repudiation of the BHP business model, albeit wrapped in a needless denigration of sausages.

"Cutting costs was the operational focus but, beyond that, he appears to have driven into his own strategic cul-de-sac"

Kerr will realise in due course that, as a chief executive, he should always choose between saying nothing or being explicit about what he means. Otherwise, he runs the risk of having others translate his slogans.  

Presumably, he sees BHP as producing unsophisticated products on a large scale, like sausages, indefinitely and unimaginatively.

The representation of BHP as a ‘sausage factory’ is not a pretty investment picture depicting, as it does, an unexciting product of economic cycles with little mastery of its own destiny.

Kerr also lamented the mining industry’s “poor track record deploying capital”. Having already been the chief financial officer of the world’s largest mining company, he would have overseen a disproportionate part of the industry’s poorly deployed spending.  

Kerr seemed to be sheeting home blame for wasted capital to a yet higher executive pay grade or, else, unaccountably misguided directors.

Australian national accounts data released this month reinforced evidence of the industry’s questionable use of capital. The data show March quarter mining industry profitability falling 85% below its 2011 peak, returning to where it was in 2005. Since then, the Australian industry has invested a staggering A$639 billion (US$472 billion) for no return. 

The industry’s annual profit should be some A$66 billion higher for an appropriate return on the capital it has invested, on my reckoning, leaving it a dauntingly high hurdle if it is to ever catch up over a full cycle.

Having someone of Kerr’s background confirm such a fundamental failing is akin to UK chancellor of the exchequer, George Osborne, declaring that the Conservative Party has never provided good government. The resulting political firestorm would have forced him, if he could survive, to explain his role in such a systemic failure and what he was going to do differently in the future.

Kerr’s observation, however, barely registered.  

Perhaps no-one cares about capital management in the industry or no-one was listening or his comment was so widely accepted as to remain uncontroversial. Kerr himself seemed to feel little compulsion to explain positively how things would differ in a company he was running.

In another apparent dig at BHP, Kerr did say he was not fixated on volumes. Cash was his priority. Cutting costs was the operational focus but, beyond that, he appears to have driven into his own strategic cul-de-sac.

He held out the prospect of paying shareholders 40% of underlying earnings over the entirety of the cycle while keeping a lid on debt and limiting investment to what remained. 

He described his attitude to expanding the company’s thermal coal involvement as “not keen”. Nickel and copper, on the other hand, he described as being “very attractive”. Unfortunately, despite their attractiveness, he could not see how to create value from them given the asking price for related assets.

Kerr’s dilemma hints at the same capital allocation predicament faced by his predecessors in the industry. After seeking to protect scarce capital at the bottom of a cycle, they were tempted to pay more as better economic conditions drove earnings and asset prices higher.  

 Kerr will have to persuade investors that South32 should not only conserve capital for the time being but also not chase assets with the onset of a new cycle. Otherwise, he’ll be no different.  

Investors might endorse the current emphasis on cash flow management but there is no evidence from past behaviour to suggest they would meekly eschew volume growth indefinitely.

Whether South32 ends up being different will also depend on whether Kerr can instil a new culture that extends beyond his likely four-to-six year tenure and not involve an executive backflip as soon as he leaves.  

Just as challenging, Kerr will have to persuade directors responsible for historically broken capital allocation models at BHP and elsewhere that their poor judgements have contributed to the problems afflicting the industry.  

Will they really accept being told that their multiple decades of experience are handicaps, not assets?

*John Robertson is a director of EIM Capital Managers, an Australia-based funds-management group. He has worked as a policy economist, business strategist and investment-market professional for nearly 30 years, after starting his career as a federal treasury economist in Canberra, Australia