Lower commodity prices accounted for most of the drop in earnings compared to last year’s bumper result. Regardless, despite much higher costs and rampant inflation, BHP delivered another excellent set of numbers as the organisation continues to slim down. More coal assets are on the way out as the ‘future facing metals’ strategy evolves.
Iron ore prices averaged US$85.46/wmt in 1H23, down from US$113.54/t in 1H22. This accounted for US$3.6bn of the fall in EBITDA to US$7.6bn in the period. The higher cost theme was prevalent here as unit costs pushed up 13% to US$18.30/t, or US$15.50/t on a C1 cost basis. Higher diesel prices and inflation plus an inventory drawdown due to labour shortages all detracted from the result. Chinese steel production is at an ebb and the outlook is uncertain on demand for seaborne iron ore. BHP WAIO production for FY23 is unchanged at 278-290mt (100% basis) with medium term guidance till over 300mtpa (studying options for 330mtpa).
Copper prices averaged US$3.49/lb in 1H23, well down on US$4.32/lb in 1H22. Higher volumes from Escondida and better performance at the Spence operation contributed positively but could only offset about half the price decline. Unit cost climbed 12% to US$1.44/lb, also reflecting higher diesel, acid and explosives costs.
Coal earnings landed near last year’s outcome with EBITDA at US$2.6bn. The Queensland Government stuck its snout in the royalties trough and was a key reason why the coal division result could have been better. The higher royalty rates, now the highest in the world, together with higher thermal coal prices subtracted $545m from the divisional EBITDA. BHP has previously divested its 80% interest in the BHP Mitsui joint venture (US$1.35bn, completion mid 2022) and will follow this with the sale of the Daunia and Blackwater mines which produce about one quarter of the BMA joint venture (BHP/Mitsubishi 50/50). Thermal coal prices averaged US$354/t compared to US$137/t in 1H22, but hard coking coal was roughly the same price at US$270/t for the period. Unit cost of production at BMA has risen to just over US$100/t and BHP sees the full year average between US$100-105/t. The horror run of wet weather in NSW shunted unit costs up 49% to US$101/t, partly because BHP was chasing higher calorific value coal given the price premium over lower value coal.
Financials. Net operating cash flow of US$6.8bn was enough to pay the US$3.5bn capex bill and fork out a US$4.6bn dividend to shareholders. Net debt at 31 December 2022 was US$6.9bn, a gearing ratio of 12.9%.
The Queensland Government royalty rate decision and the NSW Government coal price cap and reservation requirement decision have given BHP sufficient reason to effectively stymie any further spending on parts of its coal assets. The Daunia and Blackwater sales (BMA) and the potential sale of Mt Arthur in the Hunter Valley are collateral damage due to poor government policy decisions.
In contrast, the acquisition of OZ Minerals for A$9.8bn will complement the Olympic Dam and Oak Dam projects in the South Australian precinct.
Investment View
Copper prices fell sharply late in FY22, frazzled by the state of world geopolitics, but have since stabilised. There are two big picture factors to bear in mind with regards to the global copper market. Traditional end-use demand is steady. The new mega-trend of electrification (not just vehicles) is going to consume vast amounts of copper in the (near) future.
BHP earns more than half its revenue through sales to China (RIO>50%, FMG ~99%). As China re-opens its economy and winds back its COVID restrictions, there is an expectation that industrial activity will reignite and perhaps offset the softer demand developing elsewhere as economic growth slows on higher interest rates. Iron ore prices have rallied steadily on this premise providing some offset to higher operating costs.
BHP still represents an excellent exposure to the global decarbonisation theme and has a sharper portfolio of assets to achieve success. The gradual excision of underperforming assets has been handled well. An EBITDA multiple around 5.5x and PER of 11x is a fair reflection of BHP’s prospects.
Risks to Investment View
Demand and prices for commodities could decline, or operational costs could rise more than expected. There is heightened geopolitical risk currently and inflation is a key operational concern.
Recommendation
We have retained our Hold recommendation.
Figure 1: UNDERLYING EBITDA (US$M)
Figure 2: CONSENSUS ESTIMATES
Figure 3: AVERAGE COMMODITY PRICES
Figure 4: CAPITAL ALLOCATION FRAMEWORK
