BHP Heralds New Commodity World

This story features BHP GROUP LIMITED. For more info SHARE ANALYSIS: BHP

The company is included in ASX20, ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

The focus of the future BHP Group will be very much on copper, nickel, metallurgical coal and, of course, iron ore. As suspected, thermal coal is now officially slated for the exit door.

-Divestment of thermal coal assets may prove challenging
-Growth in copper, nickel and potash flagged
-Spence (copper) and South Flank (iron ore) on target for first production
 

By Eva Brocklehurst

The world of BHP Group ((BHP)) is changing. Along with FY20 results, the company has outlined the mix of commodities that will be the subject of expansion and focus for the future. As suspected, thermal coal is now officially slated for the exit door.

Most brokers welcome the exit of certain assets, as Credit Suisse points out these projects cannot compete for capital and there is also a "win" from an ESG (environment, social and governance) perspective which should be welcomed by shareholders.

In general, BHP expects major economies, with the exception of China, will contract in 2020 as a result of the pandemic, while the outlook for 2021 is uncertain. Pre-pandemic trend growth rates for China and the OECD are expected to return around 2023, while developing economies outside of eastern Asia may take longer.

Morgan Stanley notes the majority of the company's growth budget for FY22 is uncommitted which provides the flexibility to adjust expenditure, depending on market conditions. Capital expenditure guidance for FY22 is US$8.5bn.

The company made no changes to production guidance for FY21 while higher unit costs are flagged for iron ore, coal and copper. However, a lack of growth in earnings and an underwhelming dividend may hold the stock back from rally in the short term, Wilsons suspects.

The broker, while acknowledging BHP is not turning away from returning cash to shareholders, observes the need to balance this with reinvestment in order to maintain growth over the medium term. Wilsons, not one of the seven stockbrokers monitored daily on the FNArena database, remains Overweight on the materials sector.

Macquarie was disappointed with the final dividend in FY20, even though it was above the 50% minimum pay-out policy. No additional capital management was announced. Free cash flow, nevertheless, was ahead of expectations and copper accounted for 16% of group earnings (EBIT).

Shaw and Partners points out FY20 earnings were the "second-best in six years". Divisions that missed its forecasts included petroleum and coal. Meanwhile, iron ore contributed more income in the second half compared with the first half.

Old Money

The company will concentrate its coal assets on higher quality coking (metallurgical) coals and is looking to exit BMC (BHP/Mitsui Coal JV), NSW energy coal and Cerrejon (Colombia). The focus for metallurgical coal will be on assets with the longest lives.

The decision to exit thermal coal and Bass Strait was not unexpected but the planned sale of the BMC stake was more of a surprise to Macquarie. The broker suspects a sales process will take some years.

Credit Suisse suspects the decision to add BMC metallurgical coal to the exit strategy may be because it is easier to sell as a unit, while Citi points out there is a lot of work to do in considering the options and the value that can be derived for shareholders. Divestments have the potential to add up to $7bn to the broker's estimates.

Shaw and Partners notes two of the coal assets are within a previous accounting/legal legacy harking back to the Billiton merger and some tax losses could be wiped clean with the sale. Regardless, Morgans anticipates the process will be difficult, as there are a long list of thermal coal assets globally already on the market.

BHP also intends to exit non-operated assets in Bass Strait (petroleum), which Shaw notes have delivered significant cash returns over several decades. However, the broker suspects this divestment may also prove challenging, if not impossible, given the relatively short life and significant closure costs.

Citi also notes limited exploration upside in Bass Strait while recent drilling has highlighted the complexity of the field, suspecting BHP wants to avoid longer-dated and substantial clean-up costs.

The company is not looking to exit oil altogether but will be recycling capital into assets that can be expanded or brought to market such as Trion (Gulf of Mexico) and Scarborough (North West Shelf). However, UBS notes, once NWS transitions to a tolling facility it too may be divested.

New Money

Growth in copper and nickel has been flagged, through exploration and early-stage acquisitions. M&A is one possible avenue for expansion although priority will be given to early-stage prospects, reserves and resources growth and extracting more value from existing assets.

On the expansion side, the nickel footprint (Nickel West) will include the Honeymoon Well tenements and the 50% of the Albion Downs North and Jericho joint ventures in Western Australia.

Potash is also considered a "future-facing" commodity although the final investment decision on Jansen (Canada) has been moved out slightly. Brokers suspect Jansen may now get approved when it goes before the board in mid 2021. Both UBS and Credit Suisse assert the economics of this project are clouded.

The Samarco iron ore JV in Brazil, which has not produced since the tailings dam failure in November 2015, is now reincorporated in Macquarie's forecasts. BHP has approved US$44m in expenditure for its share of work related to the potential re-start.

Macquarie has reincorporated Trion into forecasts too, in light of the company's positive outlook towards the Gulf of Mexico assets. BHP Group owns 60% of the project and first production is targeted for FY25-26.

Petroleum expansion could still be on the cards, if opportunity presents.

Meanwhile, Escondida is expected to sustain reduced production, given the heavy impact from the pandemic on Chilean copper operations. The company expects Escondida to return to around 1.2mtpa in FY23.

The Spence (Chile) hypogene copper project is on track for first production in the next 12 months as is the South Flank (WA) iron ore project. Other growth projects are on schedule and on budget such as Atlantis phase 3 (US), Ruby (Trinidad) and Mad Dog phase 2 (Gulf of Mexico).

Among those stockbrokers not monitored daily on the database, Shaw and Partners has a Buy rating and $40 target while the database has four Buy ratings and three Hold. The consensus target is $39.49, signalling -0.1% downside to the last share price.

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

FNArena is proud about its track record and past achievements: Ten Years On

Click to view our Glossary of Financial Terms