Summary

  • BHP is a mining giant with leading positions in production of copper, iron ore, coal, oil and many other raw materials. 62% of revenue comes from fast growing China.
  • The company’s sales, profits and share price are in uptrend supported by rising commodity prices and expectations of the demand growth in the post-pandemic world.
  • The company’s dividend, yielding 3.8%, is safe and expected to grow.
  • Unusually high stock price runup in recent months made the company overvalued by its historical P/E ratio metric.

 

BHP Group is a leading global resources company. It extracts, processes and sells minerals, oil and gas primarily in the Americas and Australia. It is one of the top producers of major commodities like iron ore and copper. BHP has a Dual Listed Company structure with two parent companies run by unified Board and management: BHP Group Limited and BHP Group PLC (BBL). This structure provides the same voting rights and dividend entitlements irrespective of shares of which of the two companies an investor owns. For stocks traded in USD (the company reports in USD) there are two symbols:

  • Symbol BHP for the ADRs of the ordinary shares of Australia based BHP Group Limited.
  • Symbol BBL for the ADRs of the ordinary shares of the UK based BHP Group PLC.

BHP has the following operations.

  • Minerals Australia – focuses on iron ore, copper, coal and nickel.
  • Minerals Americas – produces copper concentrate, zinc concentrate and thermal coal in Chile, Peru, Brazil and other countries. The company owns 57.5% of the Escondida mine in Chile, a leading producer of copper.
  • Petroleum – global assets group.

Other units are Commercial, Centers of Excellence and Functions.

The company’s top 5 markets are China (62% of revenue), Japan (9%), South Korea (6%), Rest of Asia (6%), Australia (5%).

BHP has four reportable segments:

  • Petroleum – exploration, development and production of oil, gas and natural gas liquids (NGLs) in the US Gulf of Mexico, Canada, Australia and other countries. 9.5% of total revenue of BHP in the year ended 2020 June 30 (it is the year 2019 in our website).
  • Copper – mining of copper, silver, zinc, molybdenum, uranium and gold. 25% of total revenue. The company has large resource base with high quality deposits.
  • Iron Ore – mining of iron ore. 48% of total revenue. So iron ore is the main source of the company’s revenue. BHP is the lowest cost producer with high margins.
  • Coal – mining of metallurgical coal and energy coal. 14.5% of total revenue.

Samarco, 50% owned by BHP, had an accident in 2015. Its Fundao tailings dam in Brazil failed leading to 19 deaths and damage to the environment of Rio Doce basin. Saramco operations restarted in December 2020.

The company has minerals and metals the world needs for economic growth. Growing population and shift to greener energy are tailwinds for the company. BHP CEO Mike Henry said in 16 February News Release:

„Our outlook for global economic growth and commodity demand remains positive, with policymakers in key economies signalling a durable commitment to growth and signalling ambitions to tackle climate change. These factors, combined with population growth and rising living standards, are expected to drive continuing growth in demand for energy, metals and fertilisers. Our leadership team is in place and accelerating our agenda to be safer, lower cost and more productive.“

 

   Dividend

Dividend Dividend Yield 5Y Growth PayOut Ratio Ex-Dividend Date
USD 1.2 per share 3.8% -0.65% per year 76.4% 4 March 2021

Dividend has been volatile in recent years. Now it is almost at the same level as in 2014. The company’s dividend policy is to provide for a minimum 50% of underlying profit. It means that dividend would be lower in recessionary periods and generous when economies grow.

Current dividend yield, 3.8% is lower than that of Rio Tinto (RIO), 5.3%, but higher than Linde (LIN) or Anglo American (NGLOY) have. For the year ended 2020 June 30 dividend was 10% lower than in the previous year. It was reduced to preserve capital in the face of the pandemic related uncertainties. In that year the company’s free cash flow (FCF) amounted to USD 8.09 B and USD 6.1 B was paid in dividends leading to FCF coverage of 1.33x. Payout ratio is decent 76%. So dividend is safe as it is  well covered by both earnings and FCF. In the latest half year, ended 2020 December 31, the company’s free cash flow was USD 5.16 B. The Board decided to pay generous interim dividend of USD 1.01 per share (55% higher than last year) or USD 5.1 B in total. So almost all free cash flow is paid as dividend for that period. The company defines FCF as net operating cash flows less net investing cash flows.

The company has returned USD 30 B to shareholders in the form of dividends and buybacks over the last three years.

As the company policy links dividend to underlying profit, we could expect uneven dividend growth in the future. Including special dividends, it could be expected some growth in line with EPS growth.

   Revenue

Revenue 5Y growth Revenue growth over 2019 Company Outlook 2021
USD 42.9 B

in year ended June 2020

 

 

 

 

-0.8% per year

 

 

 

Total sales  -3.2%

By divisions:

Petroleum         -31%

Copper              -2%

Iron Ore             21%

Coal                  -32%

Expected production growth in year ended 2021 June 30:

Petroleum     -6% to -13%

Copper          -5% to -14%

Other commodities – no growth on average.

 

 

Revenue volatility in the last 5 years reflects cyclical nature of the company’s businesses. However in year ended June 2020 revenue is just slightly lower than last year despite the pandemic related disruptions. Iron Ore was the best performer supported by 16% higher iron ore prices. Petroleum and coal revenue was down as oil and coal prices were lower more than 26%. At present prices of commodities are in uptrend. Gold, copper, oil and many other commodities has had substantial runup this year.

In the half year ended December 2020 the company had record production at Western Australia Iron Ore and record concentrator throughput at Escondida.

The company expects to spend on capex USD 7.3 B in 2020 financial year and USD 8.5 B in 2021. It has four major projects under development and they are progressing well. In December 2020 first production is achieved from the Spence Growth Option. South Flank is on track to deliver first production by mid-year 2021.

BHP is optimizing product portfolio to focus on higher quality products and is making counter – cyclical acquisitions. It divested its interests in BHP Mitsui Coal, Cerrejon and recently acquired an additional interest in Shenzi oil & gas field increasing its stake to 72%.

Next year the company expects lower production of its major products. Over the medium term only low single digit growth of production is expected by the company. Also the demand for BHP products might flatten if the consumption in its major market China peaks at some point in the future. These indicate only moderate revenue growth in the coming years.

   Profitability

Profit 5Y Growth Net Profit Margin ROE
EPS USD 1.57 in year ended June 2020.

Net Profit USD 7.96 B.

34.5% p. a.

 

18.53% in year ended June 2020

18.75% in year ended June 2019

16.6 % in year ended June 2020

Despite high volatility the company has impressive EPS growth in the last 5 years, over 34% annually. Looking at the latest development, for the pandemic hit year ended June 2020, profit and EPS were only slightly lower than last year. In half year ended 31 December 2020 the company has operating profit USD 9.75, up 17% year – on – year. The main contributor was Iron Ore division which adjusted operating profit is up 47%. EPS for the period is USD 0.77 per share, down 20% year – on – year. Despite high EPS growth in the past, we could assume only single digit growth in the future, in line with revenue growth.

   Financial Strength

The Company Capital Structure

Source: Author

It can be seen from the graph that the company’s debt is lower in the latest half year. The management is focused on the debt reduction and is targeting net debt in the range of USD 12 – 17 B. At present it is at the lower end of range. Out of USD 22.72 B of total debt about USD 10 B is due in more than 5 years. Debt/Equity ratio is down from 56% last year to 42% indicating that the balance sheet of the company is healthy and improving further. Operating cash flow (USD 15.7 B) is 69% of total debt and operating profit (USD 14.42 B) is 63% of it. So debt is well covered by both operating cash flow and operating profit. Since 2016 BHP has reduced its net debt by USD 17 B. It has Standard & Poor’s credit rating A with stable outlook and Moody’s A2 with stable outlook.

   Investment case

The estimate of future stock price based on P/E ratio

Assumptions
Dividend over the next 5 years

EPS in 5 years

We assume 5% dividend growth in the next 5 years. So the total dividend income over the next 5 years would amount to USD 6.96.

EPS growth of 5% p.a. Then EPS in 5 years will be USD 2 per share.

Projected stock price
Average P/E over the last 5 years (8) multiplied by EPS in 5 years = 8 x USD 2 = USD 16

Future Returns Based on the Assumptions

Stock price upside potential                                  -48%    from the current price USD 31.08

Overall return on investment*                               -26%

Compound Annual Return on Investment             -6%

*- Includes the expected dividend income over the next 5 years and dividends are not reinvested.

In the last 4 years the company has had P/E ratio under 8 on average, roughly the same level as its peers. Current P/E is 20, more than twice above the historical average.

Macroeconomic developments over longer term are favorable for the company operations. Global population growth increases the demand for raw materials. Economic growth stimulus measures by governments could lead to higher inflation and higher raw material prices. The move to greener energy increases the demand for coper and other materials. Those trends together with the cost cutting efforts and better productivity should lead to stable growth in revenue and profits over the longer term. However all of  those expectations have led to the sharp runup of the stock price and made it expensive in historical P/E terms.

Notes

Data source – the company’s financial reports, investor presentations and its website. Source of pictures – the company website unless otherwise stated. Dividend and Sales graphs – from the company stockscreen in this website. Colored circles next to headings mean an author’s evaluation of the relevant performance criteria of the company: green means positive, yellow neutral and red negative evaluation. There are many ways to estimate the future stock price. We use only one of them, the one based on P/E ratio. All estimates made in the article are for the informational purposes only. No taxation, brokerage fees and other expenses related to investing are considered in the estimates. The estimates are the result of the rule of thumb assumptions and the real outcome might differ materially from those estimates. As the future unfolds, macro events, not mentioned in the article, could impact the company fundamentals. Use the information in the article as a starting point for your own due diligence.

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