BHP Group: Positioned to chase new growth

About the author:

Adrian Prendergast
Author name:
By Adrian Prendergast
Job title:
Senior Analyst
Date posted:
20 January 2022, 9:00 AM
Sectors Covered:
Mining, Energy

  • Over the next 12 months we are on the lookout for BHP Group’s (ASX:BHP) ‘next step’ after watching the big miner simplify its business through the divestment of petroleum and coal assets. Leaving a gap that we expect more meaningful acquisitions will fill.
  • A mixed 2Q22 operational result although with a strong performance from WAIO (iron ore), vs softer group copper production which was the key negative surprise.
  • We estimate an interim ordinary dividend for BHP of US$1.26ps, equivalent to an annualised ~7.5% dividend yield.
  • No change to our view post the 2Q22 result. BHP remains one of our key sector preferences given its robust FCF generation and yield profile.

Mixed 2Q22 operational result

Iron ore well ahead. Strong output from WAIO with 2Q22 iron ore production of 66.1mt, vs MorgE 63.1mt. This also outpaced consensus expectations of 63.8mt according to Visible Alpha. 2Q22 was impressive given the maintenance during the quarter, with BHP now expecting unit costs at the lower end of FY22 guidance.

Copper disappoints. 2Q22 group copper production disappointed (-10% vs MorgE), with: a) Escondida still impacted by COVID hurting throughput and recoveries (-5% vs consensus), b) Pampa Norte impeded by a fatality and grade drop (-26% vs consensus), and c) the major maintenance program at Olympic Dam biting harder than expected (-51% vs consensus). Antamina was a lone positive although a small contributor relative to group numbers.

Coal again soggy. Wet weather hurt coal output across both QLD Coal and NSW Energy Coal (NSWEC). This saw 2Q22 metallurgical coal volumes of 8.8mt (-15% vs consensus) and thermal coal (ex-Cerrejon) of 3.0mt (-12% vs consensus).

Guidance changes. BHP now expects FY22 copper at the low end after downgrading guidance for Pampa Norte. While BHP cut NSWEC production guidance and increased QLD Coal cost guidance. Iron ore guidance for FY22 remained unchanged, although BHP expects unit costs to be at the lower end.

Other news. Nickel West produced a reasonable 21.5kt (-2% vs consensus), while Jansen (potash) remains on schedule with development of the shaft 98% complete and BHP now tendering for Stage 1 contracts.

Analysis

Copper drag. Given Escondida makes up approximately 65% of BHP group copper production we do not expect a meaningful bounce in group copper performance until the heavy COVID impact on Escondida’s large workforce eases.

M&A. Post unification and divestments, we expect BHP to get active on the M&A hunt for larger acquisitions after simplifying its business and freeing up considerable capital resources and management capacity. If we had to guess, we would expect base metal acquisitions outside Australia as the most likely to hold some appeal (we also do not expect it to be in Africa which BHP exited when it spun off South32 in 2015). While not the bottom of the cycle by any means, we see it as the next logical step in BHP’s evolution consistent with its overarching strategy. 

Forecast and valuation update

We have updated our forecasts for 2Q22, updated guidance, and applied updated house commodity forecasts (summary further). Higher commodity prices has driven the increase in our target price to (login to view).

Net of these changes our FY22 EPS declines 2.7% to US$3.49ps, with a forecast FY22 dividend of US$2.50ps (interim DPS of US$1.26ps).

Investment view

BHP’s investment appeal has ebbed lower as its share price has rebounded off its October lows (when we upgraded our rating to Add), but despite this shrinking discount our confidence in the continuing upcycle for commodities has maintained our positive view on BHP.

We maintain our Add rating with a (login to view) target price. 

Price catalyst 

Unification (20 Jan vote). Petroleum demerger (Q2’CY22). 1H22 result (15 Feb).

Risks

COVID impact to operations and metal demand drivers.

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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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