BHP Group: Sold off into buy territory

About the author:

Adrian Prendergast
Author name:
By Adrian Prendergast
Job title:
Senior Analyst
Date posted:
20 October 2021, 10:00 AM
Sectors Covered:
Mining, Energy

  • We are still cautious on the short-term outlook for iron ore, but view the selloff as having uncovered enough value putting BHP back in buy territory.
  • We have not yet gained confidence in short-term China stimulus, but on a 12- month view we are confident based on valuation support and yield (TSR ~32%).
  • This value proposition is boosted by WPL’s share price outperformance, against a fixed equity ratio on the planned merger of WPL/BHP’s petroleum businesses.
  • A mixed 1Q22 quarter, with heavy maintenance across iron ore, copper and coal having an impact.
  • Earnings are likely to remain volatile, but BHP’s ~10% yield is hard to overlook.
  • We upgrade our rating to Add (from Hold) with an upgraded (login to view).

Relative value grows

Our cautious view on iron ore remains, but the relative value on offer in BHP has grown as: 1) BHP’s share price has fallen (now implying a US$61/t iron ore price), 2) the value of the petroleum demerger has grown with WPL’s share price outperformance (the guided 52/48 WPL/BHP merger split suggests the value attributed to BHP has grown US$3.8bn), and 3) BHP’s robust dividend profile of +10% at the current share price.

With these factors in mind, and BHP now trading at a sizable discount to our target price, we upgrade our rating to Add (from Hold).

Mixed 1Q22 operational result

1Q22 was dragged on by heavy maintenance activity in iron ore, copper and coal. Although FY22 production and unit cost guidance was unchanged.

Pilbara iron ore shipments of 70.6mt (+2% vs MorgE, -5% yoy) again was impacted by reduced access to rail labour, as well as maintenance on car loader one and rail infrastructure at Jimblebar.

Group copper production of 376.5kt was lower (-4% vs MorgE, -9% yoy) with the major maintenance program at Olympic Dam getting underway, and sustained COVID impact to Escondida (lower grade and recoveries). While output from Pampa Norte grew on ramp up of SGO.

1Q22 petroleum performance was a positive, outpacing our estimates by +1% and consensus +4% at 27.5mmboe. Volumes grew on the added Shenzi interest and startup of Ruby. BHP reported a new discovery at Calypso in Trinidad & Tobago, where drilling is ongoing.

BHP’s coal output fell short of estimates in 1Q22. Metallurgical coal production of 15.6mt (-17% vs MorgE, -11% yoy) was below consensus on a heavier-than-expected impact from planned maintenance during the quarter. While thermal coal also disappointed, hampered by a damaged ship loader at Newcastle port.

Forecast and valuation changes

We have applied upgraded coal, oil and gas and copper prices (summary later) to our estimates and adjusted our FY22 estimates for the slightly softer 1Q22. Net of these changes we have upgraded our target price to (login to view).

Investment view

Outside iron ore, BHP’s basket of commodities has gone from strength to strength, restoring some diversification and offset some of the recent weakness.

Trading at a material discount to our (login to view) target price, now with a 30% TSR, we upgrade our rating on BHP to Add recommendation (from Hold).

Price catalysts

Progress towards the petroleum demerger and unification (the latter now expected in March 2022 vs previous guidance of 1H22). 

Eventual recovery in current weak steel demand conditions.

Risks

COVID risks, demand for commodities, and BHP’s operations remains key.

Further iron ore price volatility.

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Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.


Solid top-line outcome: BAP’s 1Q22 revenue was flat on the pcp, an extremely resilient result given the extent of lockdowns in the period (~70% of stores impacted) and the strength of the pcp (cycling 27% growth). Composition comprised: Trade +2%; NZ -10%; Retail -12%; and Specialist Wholesale +7%. Overall, BAP stated that non-lockdown areas are outperforming expectations. ▪ 1Q22 trade & retail: Trade/Burson revenue was up +2% on the pcp (LFL sales - 1%; cycling 8% pcp); NZ/BNT revenue was down -10% (LFL sales -15%; cycling +4%); and Retail/Autobarn revenue was down -12% (LFL sales -16%; cycling +36%). Within the Retail segment, online sales were +80% on the pcp. Stores percentages impacted by lockdown were: Trade 70%; NZ 100%; and Retail 50%. ▪ Specialist segment results: Specialist wholesale revenue is up 7% on pcp, with Auto electrical/Truckline divisions ‘performing strongly’; and WANO underperforming. ▪ GM pressure expected to be temporary: BAP stated GM was stable across Wholesale and NZ (45% of FY21 revenue); and down ~50bps Trade and Retail (~55% of FY21 revenue), driven by promotional and online pricing in lockdown areas (we assume no margin pressure witnessed in non-lockdown areas). BAP expect margins to revert once lockdowns ease. ▪ The cost base has increased vs pcp, a function of duplicated DC costs (commencement of new VIC DC), and higher group and team member support (covid related) costs. BAP noted FY22 store rollouts and refurbs are on track.

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