Summary
- BHP is a quality mining company that benefits from China's reopening.
- The longer-term outlook is good as well, thanks to macro factors such as renewable energy investments, infrastructure spending, and so on.
- Shares are reasonably priced today and offer a hefty dividend yield.
Article Thesis
BHP Group Limited ( BHP ) is a mining giant that has seen its shares rise drastically from last year's lows on the back of positive news from China. The economic reopening will drive copper and iron ore demand in the near term, and the longer-term outlook is positive as well, thanks to trends such as renewable energy investments. Due to the recent share price increase, the valuation isn't as attractive as it used to be, however.
Beijing's Decisions Are Good For BHP
As a mining company, BHP Group naturally is cyclical -- when prices for the commodities it produces, such as copper and iron ore, are high, then profits are strong. When commodity prices are low, however, profits for BHP are lower -- in a major recession, they might even be negative. The market prices BHP accordingly, ascribing a lower value during times of low commodity prices, or when the market believes that commodity prices will decline, while BHP trades at a higher price during times of high and/or rising commodity prices.
Markets were euphoric in 2021 and early 2022 when commodity prices were high on the back of a global economic recovery. A global housing boom, caused by massive fiscal and monetary stimulus and near-zero interest rates led to growing demand for steel, copper, and so on.
During the second half of 2022, markets increasingly started to worry about a recession, however. High inflation made central bankers around the world increase interest rates, which, in turn, has resulted in an economic slowdown. China's "old" COVID policy of doing massive lockdowns in order to bring down infection rates further hurt demand for commodities, as lockdowns resulted in less economic activity.
Not surprisingly, commodities, including iron ore and copper, pulled back during that period:
That, in turn, has led to increasing demand for all kinds of industrial goods and commodities, including basic ones such as iron ore or copper, as showcased by the following charts, for copper and iron ore:
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We see that prices have headed down quite a lot between spring/summer 2022 and fall 2022. But in late 2022, commodities suddenly started to rise sharply. That's when China had announced it would change its COVID policy -- instead of pursuing Zero COVID, they would now reopen their economies and accept a higher number of infections. Of course, the restart of the most commodity-hungry economy in the world resulted in an improving demand picture -- steel producers in China started to use more iron ore, and all kinds of industries, from electronic production to housing construction and electrical grid upgrades.
China has pursued its reopening path since it originally announced those changes in its COVID policy, and it does not look like it will revert from the current path. I thus expect that current tailwinds for commodity demand, and thus for commodity pricing, will persist -- this holds true for iron ore and copper, but also for some other commodities that aren't relevant for BHP.
BHP only reports its results once every six months, thus we don't have very recent results. We can look at the results from BHP's fiscal 2022, however, which ended on June 30, 2022. During the year, BHP Group managed to generate exceptionally strong results:
The company generated earnings before interest, taxes, depreciation, and amortization (or EBITDA) of $41 billion, which was a very strong result in absolute terms, and which was also up by an attractive 16% from an already strong result in the previous year. Net income of its total operations came in at $24 billion, which was enough for an earnings per share result of $4.70. Note that one US ADR is equal to two common shares of BHP, thus the profit per ADR was $9.40.
It is not guaranteed that results during the current year will be similarly strong. It is, in fact, unlikely, as commodity prices were relatively weak during the second half of calendar year 2022, which is BHP's first half of its current fiscal year. But with commodity prices increasing meaningfully during the last couple of weeks, and with them now being at a pretty attractive level again, BHP should generate very healthy results during the fiscal second half, which is the January-June period.
EBITDA estimates for the current fiscal year are around $9 billion lower compared to the previous fiscal year. When we adjust this for taxes, we can guesstimate that net income will be around $15 billion or so this fiscal year -- if the analyst community is correct. Since commodity prices have been trending up in recent weeks, the outlook keeps improving, thus some estimate revisions to the upside wouldn't be very surprising. But even if BHP Group generates only $15 billion in net income this year, that would still be a very healthy result. Today, the company is valued at around $175 billion, which pencils out to an earnings multiple of 12 or so. If commodity prices remain where they are now, the next fiscal year could be a new record year for the company. After all, current commodity prices for iron ore and copper, the two most important commodities for BHP, are north of the Fiscal Year 2022 average, when BHP's average realized iron ore price was $113 per ton and when its average realized copper price was $4.16 per pound. Of course, it's not guaranteed that commodity prices remain where they are today. A major recession in the US, Europe, etc. could hurt commodity markets, for example. But with the strong jobs data that has been reported for the US, it does not look like a major recession is particularly likely. In fact, if there is no recession, commodities might climb further, since at least some market participants are currently assuming that there will be a recession -- if there is none, sentiment could get more bullish for commodities.
In the long run, BHP will benefit from macro growth drivers for commodities including copper and iron ore. Renewable energy investments require both steel and copper, e.g. for electrical grid upgrades, wind parks, and so on. It can be expected that the world will spend very heavily in these areas in the coming years and decades. The replacement of existing, aging infrastructure in the US, Europe, etc. will be a factor for demand as well, and growing infrastructure and housing spending in countries such as India where the middle class is growing fast should benefit commodity demand as well. At the same time, not too many mine projects are being pursued, due to regulation, costly and lengthy approval processes, and so on. Some believe that this combination will create another commodities supercycle. Overall, the outlook for producers such as BHP is far from bad, I believe.
Final Thoughts And Takeaway
The near-term picture has improved a lot for BHP and its peers in recent weeks, as Beijing's decision to open up the economy has given a major boost to commodity markets. That being said, BHP's share price has risen quite a lot in recent weeks -- shares are currently trading 43% ahead of the 52-week low. Investors that buy BHP now are thus paying somewhat of a premium price, relative to how the company was valued in the second half of last year. To some degree, that's justified due to the cleaner near-term outlook, but on the other hand, further upside potential will be more limited for those that buy right here -- after all, shares can rise the most when they are bought at a low price, and not close to 52-week highs.
Looking at BHP's valuation, we see that the stock is pretty fairly valued right now:
A 5.6x EBITDA multiple is far from high in absolute terms, but miners seldomly trade at high EBITDA multiples. Relative to BHP's own valuation in the past, shares look very reasonably priced today -- they are neither cheap nor expensive. Last summer and fall, they were a bargain -- but that's not true any longer. I thus am not particularly bullish on BHP's shares right here, but continue to see it as a high-quality miner that has some macro trends (e.g. renewable energy investing) working in its favor. The dividend yield remains attractive, as the company has paid out $6.18 over the last year, which pencils out to a 9.2% dividend yield. It's not guaranteed that the dividend will remain this high going forward, but even a 30% reduction would make for a pretty nice yield of 6.5%, while a 15% dividend reduction would result in a dividend yield of 7.8%. A pretty hefty profit hit and dividend reduction would be needed for BHP to yield less than 5% in the future. Thanks to the overall quality of the company and the pretty nice yield, I continue to hold my stake in BHP.
For further details see:
BHP: China Boost And Hefty Income