BHPLF - BHP Group: Better Commodity Outlook But Still Pricey

2023-12-28 16:35:21 ET

Summary

• The company continues to divest its lower-quality assets.
• Our internal team is more optimistic about iron ore prices backed by the decarbonization agenda, China's new stimulus, and more steel-intensive countries.
• Despite that, BHP's valuation looks full on an FCF level and an EV/EBITDA multiple basis.

In our last analysis, we were pessimistic about BHP Group ( BHP ) ( BHPLF ), and we analyzed the company's " Macro Challenges ," a higher CAPEX evolution (due to inflation) to sustain growth, a lower dividend payout ratio, and a subdued demand due to China's economic slowdown. In addition, following the OZ Minerals acquisition , we estimated that the company overpaid the target on an NPV basis. For the above reason, we reiterated our equal weight target price set at A$40 per share, in line with our previous coverage, " BHP Is Fairly Valued ." Following our last publication, shares of Australian mining companies are at record highs. BHP and Rio Tinto are back to max value following iron ore price development, better-than-expected industrial data, and Chinese new real estate stimulus . Therefore, we are back to comment on BHP's valuation with our new 2024 commodities outlook estimates.

Iron Ore Price: We Expect a Balanced Market in 2024

Following the latest trend, we are more optimistic about iron ore and steel demand. In our assumption, we are lifting the price from $100 to $125/per ton. Therefore, in our one-year visible period on the commodity price, we are confident that iron ore prices will likely range between $100-135/per ton. This is due to lower inventories, limited supply growth in 2024, and stable demand (mainly supported by the recent stimulus announcements in China). In our forward-thinking view, Southeast Asia and India also have a potential upside. These countries are reaching a level of wealth where GDP growth becomes more steel-intensive. This, coupled with China's decarbonization agenda, is a megatrend that cannot go unnoticed. Despite that, we remain cautious on the medium-term horizon as supply will likely increase in Brazil and Australia starting from 2025. In addition, there is an expected increase in supply growth in Guinea beginning in 2026 as steel scrap facilities will be replaced with iron ore production. In addition, we see Chinese steel demand at a peak level in the medium term. Here at the Lab, we should also report that CAPEX investments from mining majors are set to grow by at least 2% per year, which is equal to 115Mt in total. There has been supply disruption in recent years, and Brazil's production has disappointed due to various issues such as COVID-19 absenteeism, ramp-up challenges, and natural disasters. We see more limited risks in the future, and for the above reason, our longer-term assumption on iron ore prices is set to $85/t.

In a nutshell, we now expect the iron ore 2024 market to be more balanced. In the near term, iron ore prices might even rise to $150/t from the current spot price of $137/t , driven by seasonal supply disruptions in Brazil and Australia and restocking by Chinese steel mills. Continued supply disruption and resilient demand will support the commodity price. Still, we should also consider significant price volatility in the markets, with softer prices on lower economic data and global recession concerns versus optimism on new stimulus announcements.

BHP Group: Changes in Financials

As a reminder, BHP's EBITDA MIX is skewed to the iron ore price development, given that this commodity represents 60% of the total company exposure. Looking at the other commodities, we are also increasing the 2024 coking coal price by approximately 8% to $270/per ton, while our long-term assumption set this commodity price at $200/t. The company delivered an EBITDA of $28 billion in 2023, which was in line with consensus expectations, and declared a 66% dividend payout. Following our higher-than-anticipated commodity MIX price, we raised the BHP price objective. Indeed, our 2024 company's EBITDA projection is set to increase to almost $34 billion based on a higher commodity selling price.

We are also more optimistic about the company's CAPEX guidance. BHP continues to divest its lower-quality met coal assets (Blackwater and Daunia were sold to Whitehaven for up to $2.05 billion). In the meantime, BHP Group recently approved a $4.9 billion investment for Jansen Stage 2. Our 2024 CAPEX forecast is set at $10 billion, and in our forward view, following a $34 billion EBITDA, we arrive at a $24 billion operating cash flow. Considering the dividend payment, our 2024 year-end debt (excluding potential acquisitions and disposals) is $4.5 billion.

The company's asset base, comprised of coking coal, copper, and iron ore, is expected to generate an EBITDA margin of 55.5% in 2024 and will likely sustain generous shareholder returns. In addition, the company expects a potential green light expansion from the West Australian Iron Ore facility to 330 from 305 million tonnes per annum. Other potential add-on options include a Chilean copper brownfield facility.

Conclusion and Valuation

With our coverage, BHP's 2024 free cash flow yield is at 7%, RIO stands at 10%, and Anglo-American is above 15%. Given the decarbonization agenda, population growth, and an expected recovery in China, the company provides quality exposure to iron ore. In addition, BHP has a rock-solid balance sheet. For the above reason, we are raising our target price to reflect new higher long-term commodity price assumptions. Valuing BHP with an unchanged EV/EBITDA of 4.5x (in line with the company's historical average), we arrived at an enterprise value of $155 billion, and considering its net debt, we derived a target price of $60 per share (A$42 per share); however, this price confirmed our neutral view. Rio Tinto and Anglo-American (on a forward EV/EBITDA basis) trade at 5.25x and 4.53x, respectively, while BHP is above 6x. Within our mining coverage, we prefer the Anglo-American equity story.

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