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Date : 23/08/2021

BHP Group Limited

ASX :

BHP

Market Cap : $218.91 Billion

Dividend Per Share : $4.026

Dividend Yield : 9.12 %

Buy

52 Week Range : $33.73 - $54.55

Share Price : $44.34

Stellar dividends and cheap valuation for a long-term play. A "Buy" from us.

Company Analysis

BHP Group (ASX: BHP) is arguably the most well diversified mining and exploration company there is, and it is a part of every investor’s portfolio for different reasons – maybe for the stable dividends, or to decrease the overall volatility of the portfolio. BHP shares are also one of the best blue chip stocks that trade on the ASX. BHP derives revenues from 4 main commodities – Iron Ore, Copper, Coal, and Petroleum.

Last week, the company revealed its stunning 2021 financial year results. With an 80% increase in its profit for FY21, along with an improved underlying EBITDA, up 69%, BHP saw its free cash flow increase by 140% to US$19.4 billion – resulting in a record dividend of US$2.00 a share or $2.735 in AUD terms.


Source: Tradingview.com

Record dividend bolstered by a strong portfolio of assets

FY21 perfectly illustrates the strength of BHP’s portfolio and its balance sheet as attested by a record final dividend announced on Monday of US$2 per share which is an increase of 151% year-on-year. That takes the full year dividend for FY21 to US$ 3.01 per share – representing a payout ratio of 89%.

The record dividend was the result of operational excellence throughout the year with a strong performance that led to solid free cash flow generation and an efficient margin of 64%. BHP has achieved during FY21 record volumes at Western Australia Iron Ore (WAIO), Goonyella and Olympic Dam, and Escondida maintained average concentrator throughput at record levels. On top of that, BHP’s sturdy profit was also the reflection of high iron ore and copper prices. During the period, BHP saw its attributable profit exceptionally rise by 42% to US$ 11.3 billion despite being affected by a loss of +US$ 5.8 billion primarily related to the impairments of its potash and energy coal assets, and the current year impact of the Samarco dam failure.

Nonetheless, the group registered a strong upside for its underlying attributable profit which went up by 88% to US$ 17.1 billion. BHP reported solid improvements of its balance sheet that we think is now geared for further growth, thus net operating cash flow rose by 73% to US$ 27.2 billion, while net debt decreased by 66% to US$ 4.1 billion.

Projects are advancing rapidly

The mining giant successfully achieved its first production at four major development projects, all of which were delivered on or ahead of schedule and on budget. Furthermore, BHP acquired an additional 28% working interest in Shenzi in November last year. The Shenzi North development, a two-well subsea tie-in to the Shenzi platform, was just approved recently. In exploration, BHP progressed rapidly as well on many fronts:

  1. The company added to its early-stage options in what it names “future-facing commodities” which are copper, nickel and potash throughout the year, with the recently announced recommended all-cash takeover offer of Noront Resources in Canada.
  2. BHP also signed an agreement for a nickel exploration alliance in Canada and
  3. of a farm-in agreement for the Elliott copper project in Australia.
  4. At Oak Dam in South Australia, BHP commenced the next stage of resource definition drilling.

Furthermore, two big projects are under development, the Mad Dog Phase two in petroleum and Jansen mine shafts in potash. Both projects are neatly on track. The Mad Dog Phase two project achieved a major milestone earlier this year in April as the semi-submersible floating production platform, Argos, arrived in the US from South Korea. The first production from Mad Dog Phase 2 is expected in the middle of the 2022 calendar year. For the Jansen potash project, BHP just announced on Tuesday its approval for a US$ 7.5 billion spending to begin the mine construction. As the project is ramping up, this could mean the first potash ore output to be expected for 2027.

FY22 Outlook: Focus on “future-facing commodities”, BHP exits its petroleum business

Why did BHP shares fall on Monday despite all the positive news?
Well, we believe BHP has a bright future, hence, we remain positive in our outlook for long-term global economic growth and commodity demand. Population growth, the infrastructure of decarbonisation and rising living standards are all expected to drive demand for energy, metals, and fertilisers for decades to come and that will obviously be beneficial for the commodity giant.

What drove BHP’s share price down was the company’s announcement of its intention to exit its offshore oil and gas business to focus on what the company calls “future-facing Commodities”. This piece of news triggered a strong reaction from the market participants which we believe has been exaggerated.

We think that this is temporary before BHP’s share resumes its upside. BHP has agreed to sell its petroleum business to Woodside Petroleum (ASX: WPL) in a merger to create a top ten independent oil and gas producer worth US$ 28 billion with growth assets in Australia and the Americas. The exit from petroleum is just worth 6% of BHP’s annual earnings which is part of the company’s strategy to speed up its divestment from fossil fuels amid pressure from environmentally conscious investors.

However, it is worth noting that following the divestment, BHP shareholders will be paid in Woodside stock, giving BHP investors a 48% stake in the merged group. That effectively values BHP’s petroleum business at about US$ 13 billion as of Tuesday’s close, just about in the median of analysts’ valuations between US$ 10 billion and US$ 17 billion. In our opinion, we consider this move as pretty bullish for BHP in the long term. The world is changing and the decision of the group to separate from its petroleum arm is in line with the global trend toward decarbonisation and achieving net-zero operational emissions by 2050. We see this early move as a good approach to de-risk its portfolio of assets, furthermore, according to the company, the merger would generate annual savings of more than US$ 400 million from 2023, the year after the deal is expected to close.

Perhaps the biggest reason for the dip in share price here in Australia is the arbitrage opportunity that has popped up given BHP’s dual listing as the group’s decision to delist from the London Stock Exchange. This has led to institutional investors taking advantage of the pricing mismatch by buying the BHP stock on the London Stock Exchange and shorting the ASX stock.

What moves BHP share prices?

1. Stellar FY21 results with record dividends

2. Divestment of its $13b Petroleum arm

3. Massive investment in Potash business

4. The plan to do away with its dual-listed share structure

BHP repositioning for the future: A stronger and more competitive business

The exit of its oil and gas business appears to be the first step of BHP’s ambitious plan to turn the business toward massive growth opportunities. The giant is progressively pivoting its business toward what it names the “future-facing commodities” which comprise three resources that are expected to be in high demand: copper, nickel, and potash. We believe the recent investment and potential future growth in potash, paired with the merger of the petroleum segment with Woodside will result in a portfolio with greater net positive exposure to the mega-trends of decarbonisation and electrification. Copper, potash, nickel, and iron ore all stand to benefit from these trends, as does higher-quality metallurgical coal in the near to medium term.

The other big news from the company is the proposed unification of BHP with a single share register. The idea behind that is to simplify the corporate structure. This would also improve strategic flexibility for increasing long-term portfolio exposure towards future-facing commodities. The unification, which will see BHP Group buys its UK sister company for about $US80 billion.

All these early steps that BHP has recently undertaken such as the investment in the Jansen potash project and the petroleum arm exit, clearly show the intention of the group to pivot toward its new core business. Hence, BHP will be focussed on:

  • high-quality iron ore and metallurgical coal for the steel that is needed for infrastructure including for renewable energy,
  • copper to support unprecedented demand for renewable energy as well,
  • nickel for batteries,
  • and potash to make food production and efficient use of land.

BHP’s largest business segment is iron ore which represents 57% of the group’s revenue. Copper is the second largest contribution with 26% of the revenue, followed by coal with 8%. The Petroleum business accounts for 6%. Regarding potash, BHP expects to produce its first production by 2027 upon completion of construction of the Jansen potash mine.

Revenue forecast and valuation

BHP has reported its best annual profit in nearly a decade on the back of soaring iron ore prices. According to our analysis, we expect to see strong demand for future-facing commodities, and that the decision of BHP to pivot towards the mega-trend of decarbonisation and net-zero emission is a wise approach. Hence, we forecast a steady earnings growth at a CAGR of 5.33% for the next three years. We also think that the company will be able to maintain a comfortable EBITDA margin above 60%.

As BHP is optimising its portfolio toward high growth potential earnings drivers such as copper, nickel, and potash, we could expect substantial improvements in terms of profitability with a projected 11% plus EPS growth by FY24. Dividends are expected to follow the same growth path with DPS to expand by +35% to reach $4.09 per share in the next three years. Now looking at the valuation, we conservatively estimate BHP to be quite undervalued compared to its industry peers with a P/E ratio of 11.8 times and an EV/EBITDA of only 5 times.

Recommendation

BHP released its FY21 results on Monday and the market reacted in a quite unexpected way. BHP shares pulled back despite the company having reported its best annual profit in nearly a decade on rising iron ore prices. On the same day, BHP has also announced its intent to exit from its $13 billion petroleum business in a portfolio shake-up that will see the group leaving the London stock exchange. BHP unveiled plans to do away with its dual-listed share structure, which will make Sydney its main listing. All these corporate structural changes have one goal, to simplify the company structure for future acquisitions. Hence, BHP is pivoting its business toward the decarbonisation theme and toward net-zero emission. The group wants to focus on the development of its core business-aligned toward “future-facing commodities” which are copper, nickel, and potash which will be resources in high demand. With all these changes, we see a positive impact ahead that will continue to drive steady revenue growth for the next three years and onward. We recommend long-term investors to “Buy” as the recent share price correction and 9.12% dividend yield is too good to miss out on for income investors.

 

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