2023-03-06 12:02:11 ET
Summary
- BHP’s H1/23 results suffered from lower commodity prices.
- Management points to China’s reopening in the short-term and commodity diversification in the long-term.
- The China story is overdone, but BHP’s long-term strategy is worth a look.
BHP Group Limited’s ( BHP ) H1 FY23 results were at best, a mixed bag. EBITDA took a substantial hit while management, citing both operating cost pressures and lower commodity prices, slashed the company’s biannual dividend. Executives on the earnings call pointed to the positive effects of China’s economic reopening as being sufficient to counterbalance the impact of substantially higher interest rates in the U.S., Europe, and Japan in the coming year. That strikes one as being more of a chimera than a realistic economic projection, for if management is resting their hopes for BHP’s 12-month growth outlook on the expectation that the Chinese economy will return to the elevated growth rates of the past, they may be sorely disappointed.
However, while the immediate-term outlook may be less than great, BHP is laying the groundwork in order to fully take part in a number of commodity cycles that are slowly gaining steam. In this article, we’ll review BHP’s recent results and the steps it’s taking to ensure it partakes in major commodity moves likely to occur later this decade.
Company Background
Australia-based BHP is the world's largest mining company when measured by market cap, and although it’s often thought of as an iron ore producer, it has sizeable operations in a number of other commodities including copper and coal. And given this portfolio, it was unsurprising to see the miner’s H1/23 EBITDA come in 28% below the H1/22 number, going from $18.5 billion last year to $13.2 billion this year.
The reason for the steep pullback wasn’t production related either; in fact, production this year was higher for all three of the miner’s primary commodities. Iron ore, copper and met coal production were up 2%, 12%, and 5%, respectively, relative to the corresponding period last year. The main issue that BHP has to contend with is a broad-based decline in prices. As most readers are probably well aware, iron ore and copper prices saw sharp pullbacks in the back-half of last year, and that's a reality the miner was unable to escape.
When selling its iron, BHP was only able to realise $85.46/wmt during the final 6 months of 2023; that’s well short of the $112.65/wmt it was getting during the first half of the year and a full 25% less than the $113.54/wmt it got at the end of 2021. As can be seen from the exhibit below, the story is pretty much the same with copper.
The lone bright spot was coal (We’ll ignore nickel because it’s too small to move the needle). But even here, the good news was limited to the surge in thermal coal prices resulting from the Russia-Ukraine war. And that surge looks to be over as thermal coal prices have crashed back down to pre-war levels in recent months.
Weather-related outages and inflationary pressures played a role, but, overall, the difficult market conditions were responsible for the biggest hit on BHP's EBITDA, shaving almost $4 billion off of last year’s number. This forced management to cut the dividend down to $0.90 per share from the previous rate of $1.50.
Outlook
As is usually the case in these types of situations, management is optimistic. During the company's H1 earnings call, Mike Henry, BHP's CEO, pointed to expected strong growth in the Chinese and Indian markets over the next 12 months as being sufficient to counterbalance expected sluggishness in U.S. and European markets. He noted that, “China's reopening is progressing well with. . . bank lending, mobility data, new home prices and business surveys, all showing solid signs of improvement,” and he went onto state that, “the pent-up demand being released as China opens back up from the COVID lockdowns, coupled with the growth-promoting policies, are expected to drive stronger economic growth and increased demand for the commodities that we're producing.”
As most readers are probably well aware, Mike Henry isn’t alone in holding these views; in fact, many on Wall Street, including a lot of the financial media and the big banks, seem to believe that China's reopening will be enough to propel U.S. economic growth to new heights. The “China Reopening” story has now become conventional wisdom and is probably a big reason why commodity prices and BHP's stock price have rallied hard off last Fall’s lows.
But in spite of all that, investors may want to exercise a note of caution. It's worth remembering that China's economy was beginning to slow even before the onset of the pandemic. Its residential real estate market has been overbuilt for years, and it's difficult to imagine that a new wave of housing construction will begin now that the country’s population has begun to decline. And while manufacturing may provide China's economy with a boost, its main export markets are the US and Europe where interest rates are currently at decade highs. These factors may serve to limit the upside on BHP's stock price during the coming months while simultaneously adding a substantial amount of downside risk.
Long-Term Strategy
The company's longer-term strategy, however, holds a great deal more promise than its short-term outlook. BHP is moving into the potash business with the construction of its Jansen project in Canada. Stage 1 of the project is on track for first production in late 2026, and the company recently announced the acceleration of Stage 2 studies. Given that Russia and Belarus are the world’s second and third largest potash producers and given that geopolitical tensions show no signs of easing, producing potash in a friendly and secure nation provides plenty of potential for future growth.
BHP’s other main growth initiative is its efforts to beef up copper production, and last year the company put its money where its mouth was when it purchased the Australian copper miner OZ Minerals Limited ( OZMLF ). Granted, BHP had to pay up after its initial $5.8 billion (A$8.4 billion) offer was rejected and some analysts may believe the final $6.7 billion (A$9.6 billion) price tag may be overly generous, but one has to keep in mind that major copper discoveries have become far and few between during recent years, and Oz’s mines still have decades of life left in them. Positioning itself for the energy transition by shelling out now may eventually be looked back upon, years from now, as a very astute move.
Takeaway
But while BHP’s longer-term prospects look encouraging, the stock's recent runup combined with rising rates and slowing US and European economic growth are factors that can't be ignored. Granted, the pundits may eventually be proven right, and China's reopening might be enough to carry global commodity prices to the Promised Land. If that were to occur, and it resulted in BHP’s stock surging to new heights, never to look back, then I will have missed my chance. But I remain deeply skeptical, and, for now, rate the stock a Hold .
For further details see:
BHP Group: Future Looks Good, But The Stock Is Not Yet A Buy