BHP Group PLC (LON: BHP) – Robust earnings and free cash flow generation despite Covid-19 mayhem.

BHP Group PLC is a FTSE 100 listed mining Company which is involved in the processing of minerals, oil, and gas, primarily in the Americas and Australia. The global headquarter is in Melbourne, Australia. The Company is a global producer of metallurgical coal, iron ore, and copper. It also holds substantial interests in energy coal, oil, and gas. It is operating with an employee base of around 72,000 (including contractors), predominantly in the Americas and Australia. The Group has two parent companies, BHP Group Limited and BHP Group PLC as it operates under Dual Listing Structure.

It sells the products worldwide, with sales and marketing managed through Houston (United States) and Singapore. It has been around for 134 years, and presently, it operates in over 90 locations worldwide. The business operations include evaluation & exploration, development, extraction & processing, rehabilitation, and closure.

The Coal business is involved in the mining of thermal (energy) coal and metallurgical coal. The Iron Ore business is involved in the iron ore mining process. The Copper business is involved in the mining of gold, uranium, molybdenum, copper, zinc, silver, and lead. Petroleum comprises of exploration, production, and development activities pertinent to oil and gas operations.

 (Source: Presentation, Company Website)

Key Fundamental Statistics

Industry Outlook Dynamics

As per Technavio’s report, global crude oil market is forecasted to grow by ~US$146.92 billion between 2020 to 2024, representing a CAGR of ~1% during the period. Also, the recent report from Global Market Insights estimated that the market size for Global iron ore pellets market is projected to reach nearly US$70 billion by 2026, representing a CAGR of ~3.2% between 2020 to 2026. Meanwhile, the Technavio’s report projected, the global copper market size is expected to grow by ~3,896 thousand metric tonnes from 2018 to 2022.

The population growth and rising living standards are likely to propel the future demand for metals, fuel fertilizers, and energy. The sustainable future market would also require decarbonization of stationary power and the electrification of transport. Moreover, the increasing adoption of iron-based chemicals, growing product consumption across MEA (the Middle East and Africa) region, and rising awareness regarding the reduction of carbon emissions from steel plants would act as catalysts to drive the market forward.

However, the deepening and intensifying impact of Covid-19 would continue to impact the demand in the short-term. On Tuesday (8 September 2020), Brent oil futures tumbled below US$40 a barrel for the first time since June 2020 as Saudi Arabia cut its selling price for October amid a resurgence in Coronavirus cases around the world.

(Source: EIA Short Term Energy Outlook, Refinitiv)

In the short run, stalling crude demand outlook could hamper the profitability. However, oil has recovered from the historic lows witnessed in April 2020 due to record supply cut by OPEC and allies. The producers expect to meet again on 17 September 2020 to review the position. Fundamentally, things have not altered much as demand is recovering, storage overhang is gradually disappearing, and supply remains constrained.

Growth Prospects and Risk Assessment

BHP has a diverse and simple portfolio of tier one assets, which are of low cost, long-life, and expandable. Since 2016, it has returned ~US$36 billion to shareholders and reinvested ~US$35 billion, while the net debt (US$12 billion) kept at the low end of the target range (US$12-17 billion) in FY20. The ROCE of 17.0% in FY20 reflects strong underlying performance despite challenging operating and market conditions. The Company’s asset base can generate strong cash flows, which will boost the petroleum and copper production rate in both the short and long term. 

 (Source: Presentation, Company Website)

However, there are certain risk and uncertainties to business growth. The rebound in Covid-19 cases could weaken the global economic recovery and sap fuel demand. The price volatility of major commodities could significantly impact the profitability and liquidity position. The economic downturn is likely to keep the inflation trends and exchange rates volatile, which can further hamper the growth trajectory.

Key Recent Developments

8 September 2020: The Board of the BHP Group declared a final dividend per share of 55 US cents for the year ended 30 June 2020.

17 June 2020: The Company announced that David Lamont would join as Chief Financial Officer from 1 December 2020. He will also be joining the Company’s Executive Leadership Team.

Key Shareholders Statistics

A Glimpse of Business Segments

 (Source: Presentation, Company Website)

Measuring Non-Financial Key Performance Indicators

 (Source: Presentation, Company Website)

Financial & Operational Updates – FY2020 (30 June 2020)

(Source: Annual Report, Company Website) 

• For the financial year 2020, the Company remained focused on maximising cash flow and managed to deliver robust earnings with free cash flow generation, despite the covid-19 pandemic.
• The attributable profit and underlying attributable profit for the period stood in line with the last year’s performance.
• The Company witnessed a 9% reduction in unit costs due to improved operating stability, better productivity and foreign exchange, and delivered profit from operations and Underlying EBITDA of $14.4 billion and $22.1 billion, respectively.
• The Company generated net operating cash flow over $15 billion for the fourth consecutive year with a free cash flow of $8.1 billion.
• BHP has a strong balance sheet with a net debt of $12 billion, which is still at the lower side of the target range of $12 billion - $17 billion, due to application of IFRS 16 Leases.
• The capital expenditure stood within guidance and expects expenditure related to capital and exploration to be around $7 billion for the financial year 2021.
• At present, the Company has 6 major projects under development, and all are progressing well.
• BHP is focused on maintaining the safety of employees and communities with no fatalities and improved Total Recordable Injury Frequency. The Company also maintained safety protocols during the covid-19 pandemic.
• The Company consistently delivering high cash returns to shareholders and is determined to pay a dividend of 55 US cents per share with a strong underlying ROCE (return on capital employed) of 17%.

Financial Ratios – Strong Profitability Margins versus the Industry Median

Reported profitability metrics for the financial year 2020 were higher against the industry median, reflecting higher revenue generated and better control over expenses as compared to the industry.

BHP Group Plc has delivered a substantial return for the shareholders’ as return on equity of 16.7% was higher as compared to the industry median of 6.1%. On the liquidity front, BHP Group Plc’s current ratio was lower than the industry median of 1.85x but had sufficient liquidity to meet short-term obligations.

On leverage front, the debt-equity ratio was 0.56x, which was higher as compared to the industry median of 0.40x, reflecting that the company is more leveraged as compared to the industry.  

Share Price Performance Analysis

Daily Chart as on 9 September 2020, before the market close (Source: Refinitiv, Thomson Reuters)

On 9 September 2020 (before the market close, at 9:13 AM GMT+1), BHP Group Plc shares were trading at GBX 1,707.00, up by 0.99% against the previous day closing price. Stock 52-week High was GBX 1,873.00 and Low of GBX 939.80, respectively.

BHP Group Plc Vs FTSE-100 Index (5 Years)

(Source: Refinitiv, Thomson Reuters)

In the last five years, BHP Group Plc share price has delivered ~59.29 per cent return as compared to negative ~3.93 per cent return of FTSE-100 index, which shows that the stock has outperformed the index during the last five years.

Valuation Methodology: Price/Earnings Approach (NTM) (Illustrative)

Business Outlook Scenario

The potential for re-emergence of Covid-19 outbreaks in supply jurisdictions or key markets is keeping the outlook uncertain. The Global crude steel production is likely to decline in 2020 though long-term prospects seem favourable. The prices of iron ore and coal have also weakened off lately. Adjacently, the crude oil price has also been experiencing volatility in the second half of 2020. However, BHP has a strong balance sheet with high quality and diversified portfolio of assets to show resilience against uncertain commodities market. The Company is confident towards the demand for products in the medium period to longer-term period with the generation of solid cash flow.

The production guidance is summarised below:

(Source: Company Website)

In the short run, stalling crude demand outlook could hamper the profitability. However, oil has recovered from the historic lows witnessed in April 2020 due to record supply cut by OPEC (Organisation of the Petroleum Exporting Countries) and allies. The producers expect to meet again on 17 September 2020 to review the position. Fundamentally, things have not altered much as demand is recovering, storage overhang is gradually disappearing, and supply remains constrained.

 (Source: Presentation, Company Website)

Considering the strong cash flow generation, better productivity, and support from the valuation as done using the above method, we have given a “Buy” recommendation on BHP Group Plc at the current price of GBX 1,707.00 (as on 9 September 2020, before the market close at 9:13 AM GMT+1), with high single-digit upside potential based on 13.57x Price/NTM Earnings (approx.) on FY21E earnings per share (approx.). 

*Dividend Yield may vary as per the stock price movement.

*All forecasted figures and Peer information have been taken from Refinitiv, Thomson Reuters.

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