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Date : 21/02/2023

BHP Group

ASX :

BHP

Market Cap : $245.48 Billion

Dividend Per Share : $4.6

Dividend Yield : 9.08 %

Hold

52 Week Range : $35.83 - $50.21

Share Price : $48.33

Large and diversified miner to benefit from the fifth commodity supercycle in the long term. Share price currently trading near all-time highs and we recommended a hold and buy at lower levels.

Company Analysis

Shares of ASX’s largest company BHP Group (ASX: BHP) are trading almost flat after the company’s 1HY23 results came in slightly below analysts’ expectations. The company’s earnings showed a 32% decline to pcp (1HY22), and it reduced the interim dividend payout by 40% (based on constant US currency terms).

We’ve written about BHP before and have had buy recommendations on the stock every time. You can find our latest report here. BHP operates as a resources company in Australia and internationally with a portfolio of high-quality assets across various commodities in base metals, coal and fertilizers. BHP recorded record-high revenue and earnings in FY22, driven by soaring commodity prices. But now, the company’s financial performance is normalising after the widespread correction in most commodity prices that took place in the last several months. In the following, we’ll discuss the performance and medium-term outlook for each of BHP’s most important commodities.

Commodities review and outlook

Iron ore: Global steel production softened in 1HY23 in line with the weakening economic outlook across the world, led by Europe, and steel makers across all regions saw their margins squeezed with lower sale prices intersecting with high input costs. As a result, the iron ore market spent much of the period at or slightly above real-time cost support in the US$80-US$100 CFR range. The price moved above that range late in the period, on the expectation that demand conditions would firm in China on the back of pro-growth policies. But in the medium term, China’s demand for iron ore is expected to be lower than what it is today as crude steel production plateaus and the scrap-to-steel ratio rises. In the long-term, prices are expected to be determined by high-cost production, on a value-in-use adjusted basis, from Australia or Brazil. BHP has the lowest cost iron ore production in the world, and we think this would help the company to stay very competitive in the expected competitive environment.

Coal: Metallurgical coal prices were less volatile in the period as seaborne trade progressively adjusted to the shock of the Russian invasion of Ukraine. On the demand side, less global iron production reduced demand, but conditions on the supply side remained tight; adverse weather conditions in Australia and Canada and the diversion of some metallurgical coal to power generation under record high energy coal pricing offered some support to the market. In the long term, BHP believes higher quality metallurgical coals will continue to be required in blast furnace steel making for decades, driven by the growth of the steel industry in hard coking coal importing countries such as India. Premium Hard Coking Coals are expected to be valued for their role in reducing the greenhouse gas emissions intensity of blast furnaces. But China’s import policy remains a source of uncertainty.

Copper: Prices fell sharply early in the period as demand risks in the developed world mounted. Prices then traded in a well-defined range for much of the period, with US$7000/t being the approximate floor price. Low visible inventories and below-average industry-wide supply performance prevented prices from falling further. In the medium term, BHP expects to see similar copper prices driven by a forecast supply and demand balance. But longer-term, traditional end-use demand is expected to be solid, and the electrification mega-trend offers an attractive upside to copper prices.

Nickel: prices in the period were volatile and while supply side and inventories remain tight, demand risks have weighed heavily on investor sentiment. BHP believes in the long-term, nickel will be a core beneficiary of the electrification mega-trend as well.

Potash: prices declined steadily throughout the period as affordability deteriorated, unwinding the steep price spike that developed in the wake of Belarusian sanctions (the largest potash producer in the world). BHP believed longer term potash stands to benefit from the intersection of global megatrends: rising population changing diets and the need for the sustainable intensification of agriculture on finite arable land.

Investment thesis

BHP continued to see the lagged impact of inflationary pressures in the period, in particular for diesel, with an effective inflation rate of approximately 12 per cent. Other costs also increased, including labour costs and availability and inventory and logistics costs. Significant wet weather conditions also impacted coal production and costs. The company expects to continue to see the lagged impact of inflationary pressures into FY24.

BHP’s 1HY23 operating profits decreased by 24% compared to pcp as a result of lower realised prices for iron ore and copper, higher royalties as a result of the increased Queensland Government royalty rates and inflationary impacts across the group, partially offset by record production at WAIO (Western Australia Iron Ore operations), higher realised prices for thermal coal and nickel, and favourable exchange rate movements. BHP’s earnings, however, showed a 32% drop to pcp. It was because of the profit after tax from discontinued operations of US$972 in 1HY22 that did not repeat in 1HY23.

BHP’s free cash flow also significantly declined in the period, from US$9.7bn in 1HY22 to US$3.5bn in 1HY23, driven by lower operating cash flow and higher capital expenditures in the period. As such, the company declared a fully franked interim dividend of US90 cents, 40% lower on pcp, with a record date of 10 March 2023 and a payment date of 30 March 2023. This is equivalent to a 69% payout ratio (78% for the pcp).

BHP’s stock is covered by 16 analysts, and based on their consensus estimate, BHP is expected to deliver earnings per share of $4.38 in FY23, 25% lower than FY22. But we think this expectation might prove too optimistic. However, even assuming a similar 32% decline to 2HY23 earnings compared to pcp, BHP’s stock is trading at a forward P/E multiple of 12.2x with a forward fully franked dividend yield of 5.66% at the current share price of $48.28 (Assuming a similar payout ratio of 69% for the final dividend).

Recommendation

The cyclical nature of BHP’s business makes its earnings and dividend payouts vulnerable to the current economic slowdown. But we think despite an expected medium-term softness in commodity prices, the long-term outlook is defined by the ongoing fifth commodity Supercycle that started in 2021, which is expected to last for the next 15 to 20 years and is driven by the renewable energy transition and electrification mega-trend. Population growth, rising living standards and infrastructure required for decarbonisation are all expected to drive demand for steel, non-ferrous metals and fertilizers for decades to come.

Given the expected volatility in BHP’s operating environment in the medium term, and the fact that its share price is trading near the all-time high levels, we think new buyers can wait for more attractive prices, such as $43.00 and $41.00 at 50% and 61.8% Fibonacci levels, respectively. As such, we recommend a “HOLD” on BHP.

 

BHP Group, Weekly Chart in Semi-log Scale (Source: Metastock)

 

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