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What’s Next For BHP Group After Iron Ore Falls?

Australia | Jul 21 2021

This story features BHP GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: BHP

BHP Group's production performance impressed in the June quarter as the iron ore division continued its stellar run. Yet, what will garner attention when the iron ore price inevitably falls?

-Focus on capital management and divestments likely at the August results
-Fundamental support continues for the share price, yet is the upside limited?
-Is BHP Group planning to accelerate the exit from fossil fuels?

 

By Eva Brocklehurst

Upside for BHP Group ((BHP)) earnings in FY22 is predicated on the trajectory of iron ore prices, which continue to defy expectations and remain at record highs. Outside of iron ore, there is a noted softening in guidance for copper and coal.

Yet Shaw and Partners believes it is worth highlighting the achievement in BHP's operations under the CEO Mike Henry, as the company is now the lowest cost iron ore miner globally.

June quarter numbers may have been sound but the guidance for FY22 is a little soft for Credit Suisse's liking. The iron ore division continued its stellar run in FY21 yet production guidance implies a flat or only marginal increase for FY22.

Still spot iron ore prices should provide a buffer for any volume downside, the broker acknowledges, and the focus will be on capital management and consolidation of the portfolio at the August results.

Assuming 100% pay-out of earnings per share the broker forecasts a total dividend of US$2.17 per share equating to an annualised dividend yield of 11%. Citi forecasts FY21 dividends of US$3.28/share at a pay-out ratio of 95% and notes FY21 net debt is forecast at $8.7bn, implying additional capital management potential of around $3-8bn.

Western Australian iron ore production is guided at 278-288mt while petroleum is guided at 99-106mmboe, which suggests an improvement year-on-year. Copper guidance is 1.59-1.76mt metallurgical coal 39-44mt and NSW thermal coal 13-15mt.

Guidance for Cerrejon has been withdrawn as divestment is expected to be finalised in the first half of 2022. BHP will recognise an impairment charge of -US$85m in the FY21 results.

While costs are within guidance there will be a hit to the profit & loss at the August results from higher rehabilitation and closure costs as well as depreciation. Credit Suisse notes rehabilitation costs may be a one-off but the depreciation impact will linger.

South Flank achieved first production in May and the ramp-up of this project is expected to lift the quality of iron ore production. The Western Australia iron ore division's port licence is expected in the next six months.

Both major projects, Mad Dog (oil & gas) and Jansen (potash) are on track, with a final investment decision on the latter due in the next two months. Ord Minnett would not be surprised if there was a write-down of the carrying value of Jansen, which is being assessed.

Outlook

Incorporating a softer outlook for copper and coal and higher unit costs drives -5% reductions to Macquarie's estimates for FY22-24. Macquarie reduces copper production forecasts by -5-8% over the next three years and flattens the volume outlook for thermal coal.

Yet the upside from iron ore revenue more than offsets this, in the broker's view, and this presents the most material risk to forecasts. Shipment volumes from BHP have been consistent, Macquarie notes, and the strong performance in the June quarter is undoubtedly attributable to South Flank which delivered its first ore in May.

Goldman Sachs expects 7% copper equivalent growth in FY23 amid the full ramp-up of Spence (copper) in Chile and several new conventional oil projects in the Gulf of Mexico. Sulphides are expected to double production at Spence by the end of FY22.

The strength of the company's fundamental support the share price although Morgans asserts limited upside potential affects its conviction beyond the attractive yield on offer, while UBS considers the risk/reward is balanced as high cash returns are supportive of the share price in the near term, although the iron ore price is vulnerable to a retracement from its lofty heights.

Ord Minnett, on the other hand, makes the comparison with Rio Tinto ((RIO)) which had a fraught June quarter. Rio Tinto's shipments were down on the March quarter and the achieved price was -US$3/t below BHP's, which had strong performances at Yandi and Mining Area C despite significant impacts from weather and temporary rail labour shortages.

Citi was also pleased with the copper production at Olympic Dam of 205,000t but with a large scale smelter maintenance program scheduled for the first half of FY22 guidance is 140-170,000t.

Olympic Dam stood out for Shaw too, providing the highest copper production under BHP stewardship as well as record gold production. The broker highlights four major projects were delivered on time and budget during the financial year.

Divestments

BHP has previously stated it was looking to divest its metallurgical coal assets although an update on the sale process was not provided, nor was there any update on the divestment of the NSW thermal coal assets. The company expects Chinese restrictions on Australian coal will continue for a number of years.

Morgan Stanley notes media speculation that BHP may be considering exiting the petroleum business in order to accelerate a complete exit from fossil fuel commodities.

The speculation implies the business could be worth around US$15bn. While the company has not commented, the broker believes an exit of fossil fuels could enhance the investment case and ESG credentials significantly.

That said, management has consistently remarked on the attractive nature of the oil & gas business and revealed a willingness to continue investing in these opportunities to improve returns. Morgan Stanley values this segment at US$11.3bn, estimating operating earnings (EBITDA) in FY21 were around 6% of the group total.

Among those stockbrokers not monitored daily on the FNArena database, Shaw and Partners has a Buy rating and $56.00 target for BHP Group while Goldman Sachs has a Buy rating and $57.70 target.

FNArena's database has three Buy ratings and four Hold. The consensus target is $50.53, signalling 0.9% upside to the last share price. Targets range from $42 (UBS) to $60 (Macquarie, Ord Minnett). The forecast dividend yield, on present FX values, is 7.7% and 7.6% for FY21 and FY22, respectively.

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