2023-09-07 05:57:37 ET
Summary
- Sticky costs and higher capex evolution will likely add pressure on BHP's return trajectory.
- Here at the Lab, considering China's real estate market, we are cautious about the commodity outlook.
- We believe that BHP is fairly priced with dividend yield estimates that do not support downside protection.
At the Lab, we were not optimistic about BHP's " Macro Challenges ." In our last analysis, considering the company's CAPEX development with potential higher cost, we reiterated a neutral valuation ([[BHP]], [[BHPLF]]). In the meantime, BHP released its full-year-end financial results, and some headwinds are coming online.
According to Bloomberg , the latest steel and iron ore data suggest that demand could contract for the remainder part of the year. Despite other industries holding up demand and a slowdown in the July industrial production, China's real estate market is still in the doldrums, with authorities that have not been willing to encourage massive construction. China is BHP's largest iron customer and the economic outlook deterioration could impact a double-digit percentage of the company's earnings. Beijing has implemented " policies intended to stimulate new beginnings " in the real estate sector, " but they are not translating as effectively into changes on the ground as we expected ," said CEO Mike Henry in the latest interview.
BHP Latest Results
The largest mining company (by market cap) reported the following numbers:
- Top-line sales at $53.8 billion versus a consensus expectation of $54.2 billion;
- EBITDA of $28.0 billion compared to an average Wall Street estimate of 28.1 billion;
- Dividend at $170 cents vs. consensus at $174 cents. The board proposed a final dividend of $80 cents per share, equivalent to a 64% payout ratio (from the previous $80 US cents per share with a payout of 69%).
Here at the Lab, we were right on the CAPEX and net debt evolution while forecasting a dividend in line with the previous company's guidance. Despite having missed expectations, BHP recorded solid results; however, Wall Street analysts should price a CAPEX lift and lower return for the next visible period. In numbers, net debt reached $11 billion from the $0.3 billion at the 2022 Fiscal year-end, but this includes $8 related to the OZL acquisition . "Our previous analysis indicated that BHP's debt will increase by almost $10 billion ." Related to the CAPEX, BHP anticipates a new investment of at least $10 billion annually. On a negative note, the WAIO mining facility maintenance CAPEX is set to increase for an incremental volume of $5.5 per ton on the medium-term guidance.
Here at the Lab, this is not coming as a major surprise. But, looking at Wall Street estimates, on average, they were guiding for $9.3 and $8 billion in 2024 and 2025, respectively. This seems to be a constant headwind within the sector; however, it is due to under-investment due to weak commodities prices recorded from 2013 and 2016. The mining sector is a cyclical business, and unfortunately, we are in a period where costs are elevated due to high energy costs and inflationary pressure.
On the positive side, BHP disclosed that OZL synergies could increase by>$50 million annually (by 2024). This is explained by asset optimization and an integrated supply chain with procurement cost savings. Potash Jansen is 25% completed and expected to start production in 2029. BHP also emphasized how India is becoming a significant customer of metallurgical coal used in steelmaking. This might represent a bright spot for global demand and is supported by the local government, which aims to double steel production capacity, bringing it to 300 million tons annually by 2030. However, this positive news does not fully offset the cautious commodity outlook, China's real estate demand, and cost evolutions.
Changes to Estimates and Conclusion
Following the latest unit cost guidance, we are revising our top-line sales estimates downwards. For 2024, we reached a turnover of $55.28 billion with an EBITDA of $28.5 billion. Having listened to the Q&A call, BHP's management provided a limited disclosure on the CAPEX timing development related to the company's potential return. Here at the Lab, investment returns will likely be beyond 2030.
BHP: Production and unit cost guidance
Still related to next year, considering the CAPEX plan, we arrived at an FCF estimate of $8.35 billion, and we forecast a DPS of 120 cents, considering a payout of 50%. This means an FCF yield of 5.6% with a dividend yield lower than 3%, while Rio Tinto 's FCF ratio is slightly above 8%, with a forecast dividend yield of 6.11%.
BHP flagged many new projects beyond the ones that are already in progress. CAPEX is elevated, and the need to build more supply for longer-term demand while weak commodities might hit the company's stock price development. While BHP is moving on with an element of growth, there is a sense of running to stand still. The company's current valuation is 6x its EV/EBITDA vs. a past average of 4.5x. Looking at our peers' valuations on the EV/EBITDA, Rio Tinto, Anglo-American , and Glencore are currently trading at 4.68x, 4.15x, and 3.92x, respectively. With a projected dividend yield in the low-single-digit, and considering its high valuation vs. peers, BHP is not an investment to overweight. Elevated CAPEX requirements and potential lower shareholders' return confirm our equal valuation with a target of A$40, reiterating our previous coverage titled " BHP Is Fairly Valued ." Investment risk within the mining sector includes but is not limited to, commodity price changes and adverse currency development. Furthermore, BHP is subject to financial, political, and operational risks, and each of these risks has the potential to impact the company's performance significantly. Given the $10 billion in debt and the CAPEX growth plan, rising interest rates and inflation might also impact BHP's profitability.
For further details see:
BHP Is Between A Rock And A Hard Place