Can BHP Keep Delivering?

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BHP has surprised with a massive dividend, but plans from here are to increase spending for growth in future-facing commodities.

-BHP's dividend surprises to the upside
-Free cash flow bonanza
-Big lift in growth plans
-Spending on the future

By Greg Peel

BHP Group ((BHP)) reported earnings yesterday in line with or slightly better than forecasts. But earnings were not the focus.

The result contained two major surprises – the size of the dividend payout and the extent of capex planned over the next several years.

The final dividend of US$1.75 was well ahead of consensus, and represents a 77% payout ratio. We recall rival Rio Tinto ((RIO)) cut its payout to 50% from 75% citing uncertainty around the direction of commodity prices.

The extent of the dividend was even more surprising given BHP also managed to reduce its debt to “near zero” – actually US$0.3bn but BHP could find that down the back of the couch – as had Rio, and also has a bid on the table for OZ Minerals ((OZL)).

The dividend payout was backed by a free cash flow result that also handsomely beat forecasts. The US$24.3bn achieved included US$3bn in FY22 tax to be paid in FY23 – so just a timing issue – but also a lower Aussie dollar and lower Chilean peso which helped reduce operating and capital spending costs to below broker expectations in an inflation-impacted environment.

Coal earnings also surprised, being more than enough to fill the gap from lower iron ore prices over the year.

Kid in a lolly shop

So, what to do when you’re swimming in cash? Spend it!

BHP announced an increase in capex guidance from US$6bn in FY22 to US$7.6bn in FY23, US$9bn in FY24 and US$10bn in FY25-27, well ahead of broker assumptions.

Over half of the spending is focused on “future-facing” commodities, but nothing exotic – specifically copper and nickel – which has EV growth written all over it. Copper and nickel are hardly new commodities for BHP.

OZ Minerals produces copper and nickel. Management admitted that despite the OZ Minerals board dismissing BHP’s advances out of hand, the price being offered is on the high-side. Brokers doubt that will prevent a higher price being offered.

Some of the capex will be used to increase production of the Western Australian Iron Ore division from a current 290m tonnes per year to 300mtpa by FY28. There is a further plan to possibly lift that to 330mtpa, but by spending on operational efficiencies (access to port) rather than more ore per se.

Then there’s potash. BHP had been quiet on its Jansen project for a while but given the world’s biggest suppliers of fertiliser are (were) Russia and Belarus, the incentive to dig up old bird droppings in Canada has increased.

Capex is targeted at both organic growth and M&A, but in the latter case brokers expect only bolt-on acquisitions (eg OZ) rather than any game-changing moves.

The end of big payouts?

Investors will soon see trucks backing up to their door when the dividend is paid, but if the plan now is to spend up big, have they seen peak dividends?

Not necessarily, brokers suggest.

On the strength of free cash flow, no debt and currency support, brokers assume the big payouts can still keep coming – maybe not as big as 77%, but still substantial.

The point is BHP is not spending to survive, it's spending to grow. While management did not go into any detail about exactly what it will spend money on, brokers have been quick to speculate.

Suggestions include organic growth-wise, Jansen (potash) stages 1 and Escondida (copper) concentrator leaching, Olympic Dam (copper) smelting, as well as iron ore production. Money can also be spent on efficiency of existing operations, as may be the case in iron ore.

As for M&A, well OZ provides a clue.

In theory growth provides for more cash flow, and thus ongoing dividends.

Risks?

The direction of commodity prices, obviously. Rio is cautious on this front, and is holding back earnings just in case, although brokers suspect a bigger payout will be forthcoming with the final divided.

On a near term basis, the risk of a global recession looms large. We note a big drop in prices across the commodity spectrum this week when China posted weaker than expected July data – China being rather critical to global growth. But BHP has growth plans out to FY28, and beyond.

Copper and nickel prices may have come well off their highs but it is generally agreed that there ultimately will not be enough copper and nickel in the world to meet demand growth for EVs, wind turbines, solar panels and just about anything in an electrified future. Not at the current rate of production and exploration.

BHP is keen to face this future.

There is nevertheless a question as to how increased iron ore production might impact the global iron ore price. BHP is pretty certain China’s not about to stop making steel anytime soon.

While a couple of FNArena database brokers are still getting over the shock (have not yet updated), and Citi is on research restriction (OZ Minerals takeover), broker ratings are unmoved from two Buy (or equivalent) ratings and four Hold.

Earnings forecasts have been trimmed to account for increased capex but the consensus target price has ticked up to $42.38 (so far) from $42.35. This suggests only 3.4% upside, noting BHP rallied 4.1% yesterday on result, which explains why four brokers see valuation as fair.

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