BHP Group: BHP might avoid classic industry mistake

About the author:

Adrian Prendergast
Author name:
By Adrian Prendergast
Job title:
Senior Analyst
Date posted:
15 February 2022, 4:00 PM
Sectors Covered:
Mining, Energy

  • The further upcycles extend and longer earnings remain elevated the harder it becomes for miners to maintain capital discipline. We cannot rule out this risk for BHP Group (ASX:BHP), but the big miner continues to give all the right signals.
  • Sticking to its capital allocation framework, strong earnings saw BHP flex its payout ratio to 78% for a record interim dividend of US$1.50ps (+21% vs consensus).
  • 1H22 EBITDA was +1% vs consensus, while underlying NPAT was a more significant +11% vs consensus. With strong operating CF and FCF generation.

Bumper first half

As we expected a strong result from BHP, who more easily combated inflationary pressures during the period thanks to its larger labour resources and lack of WA-based construction projects. Two factors unique to BHP vs local peers.

BHP posted group revenue (+3%) and underlying EBITDA (+1%) modestly ahead of consensus estimates. While underlying attributable NPAT of US$10,687m was a comfortable beat (vs consensus US$9,261m vs MorgE US$9,731m). The biggest difference being the timing of tax instalments, which will also be a factor in 2H22.

1H22 operating cash flow of US$11,529m was similarly 10% ahead of consensus, leading to a strong FCF result of US$9,688m (vs consensus US$6,976m vs MorgE US$7,540m).

Strong cash flow generation and a US$0.5bn reduction in liabilities across assets held for sale, led to net debt plunging from US$11.9bn to just US$6.0bn by the end of December, for gearing of just 3%. While BHP widened and lowered its target net debt range to US$5-$15bn to allow for more flexibility around big dividends/deals.

No change to FY22 production or unit cost guidance since its quarterly, with a US$200m reduction in capex guidance to US$6.5bn (FX swing).

Can BHP remain disciplined?

Remembering previous cycles it has been typically true in the mining industry that the discipline of management peaks at the bottom of each cycle. While the longer earnings remain buoyant, the greater the incentive becomes for an overpriced acquisition.

This is relevant to BHP after six years of bumper earnings, low single-digit gearing and a lack of committed future capex.

Obviously cognisant of these market fears, BHP did a solid job reassuring us in this result around its broader plans.

Keen to transition its portfolio to commodities exposed to future mega trends, but equally BHP management do not feel they “have to” make a move if they cannot find value, as evidenced by BHP pulling out of the race for TSX-listed nickel player Norront Resources due to price.

Reaffirming its stance, BHP maintained that it would be content with paying elevated shareholder distributions over the long term if it cannot locate value accretive organic growth and/or M&A opportunities.

Forecast and valuation update

We have updated our FY22 estimates for the 1H22 result, reduced our FY22 capex assumptions (from US$7bn to ~US$6.5bn), increased our assumed 1H23 payout ratio assumption (to 70% from 60%), and rolled our model forward.

Net of these changes our valuation-based target price has increased slightly to (login to view).

Investment view

Although a strong 1H22 result, BHP’s share price has already performed strongly, closing the gap on our target price.

Viewing BHP as close to fair value, we revise our rating to Hold (from Add). Although noting it remains one of our most preferred sector exposures.

Price catalysts

  • Petroleum demerger.
  • 3Q22 operational/cost result.
  • FY22 dividend/capital management.

Risks

  • COVID risks to operations and end-markets.
  • China macro drivers

Find out more

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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.

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