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BHP Group - profits up but cautious on global outlook

Emilie Stevens, Equity Analyst | 18 February 2020 | A A A
BHP Group - profits up but cautious on global outlook

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BHP Group Plc Ordinary US$0.50

Sell: 1,552.20 | Buy: 1,553.20 | Change 0.00 (0.00%)
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Underlying profits from continuing operations rose 29% to $5.2bn, with higher iron ore and copper prices offsetting declines in petroleum and a marked decline in coal.

BHP are on track to meet full year production and unit cost guidance but warned if coronavirus is not contained over the March quarter, they'll have to revise their commodity demand expectations downwards.

An interim dividend of 65 cents per share was announced, up from 55 cents last year - well above the group's minimum dividend policy of paying out 50% of earnings.

The shares fell 1.4% in early trading.

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Our view

Mining is a superficially simple business.

Market Price - Cost of Extraction = Profit

Done.

In reality of course there are central operating costs to consider, interest payments to make and the whole host of factors that drive commodity prices and extraction costs too. Once something's been dug up, it can't be dug up again, which means exploration costs are also a constant burden.

Still it's this simple profit equation that lies at the heart of why BHP stands out from the crowd.

Iron ore is BHP's most important commodity by some way, and its high-quality assets mean extraction costs are very low. A tonne of iron ore costs BHP as little as $13.03, well below the average price of $78.30 received in the last six months. It's much the same story across the rest of the group. This should make BHP a giant cash machine.

Unfortunately not all the factors that affect the group's performance are under its control. When commodity prices crash, they crash everywhere, for everyone. Anyone holding the shares through the commodity crash of 2014/15 will know that only too well.

BHP's high quality, high margin assets mean even at the bottom of the cycle, its mines remained robustly profitable. Lower market prices mean lower profits, but as long as debt and central costs are kept under control BHP should be able to weather any storm.

That's lucky, because things look a little turbulent at the moment. A slowing Chinese economy and growing trade tensions are bad news for natural resources groups - since demand for iron ore and other industrial commodities tends to go a bit rusty during a downturn.

BHP targets paying out a minimum of 50% of earnings, which in a highly cyclical industry is a sensible approach. However, it also means that payments to shareholders could tumble if commodity prices take a turn for the worse, especially as BHP has actually paid out significantly more than the minimum recently. Analysts are forecasting a 5.7% prospective yield.

To be fair, debts look a lot more manageable and that provides the group with flexibility. If you can deleverage while still paying a healthy dividend, why wouldn't you? Nonetheless the allocation of cash between balance sheet, capital expenditure and shareholders is an area we'll be paying close attention to.

Overall we think BHP's asset base means it should be well placed to weather the ups and downs of commodities. The current price to book ratio of 1.8 times is some way below the long term average, and that could make for an attractive entry point - assuming of course that management don't overcommit on the dividend, or get overconfident on debt levels.

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Half Year Results

BHP's revenue rose 7% to $22.3bn, mainly driven by the Iron Ore division.

Iron Ore sales rose 40% to $10.4bn, reflecting a 41% increase in average Iron Ore price and a 2% rise in production. Copper, BHP's second largest division by revenue, saw sales rise 11% to $5.6bn, with production up 7% and prices up 2%. Petroleum revenues fell 23% $2.5bn, driven by a lower oil price and production, and Coal sales were down 28% to $3.3bn.

Despite mining unit costs falling in all divisions other than coal, operating costs rose 5% to $14.3bn, mostly reflecting costs of doing business outside of BHP's control.

Free cash flow from continuing operations rose 4% to $3.7bn. That reflects a rise in cash generated from operations to $7.4bn and capital expenditure of $3.8bn - mainly focussed on new mineral project investment.

Net debt finished the half $2.2bn higher at $12.8bn, reflecting the record $3.9bn full year dividend payment and a change to accounting rules. The gearing (the ratio of net debt to net debt plus net assets) now stands 19.7%, up from 16.1%.

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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

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