1 meet, 1 beat but 2 wildly different futures for these miners

Glenn Freeman

Livewire Markets

The Big Australian’s share price has remained flat despite BHP Group’s (ASX: BHP) half-yearly $10.7 billion NPAT result this week, which broke its prior record by around 75% and fell just short of its $11.1 billion record interim profit set in 2H21. The company also reported a record dividend of $1.50 a share, ahead of the market’s expectation of $1.24.

The muted share price reaction is explained largely by the dip in iron ore prices. The commodity price was down 10% on Tuesday 15 February on rising speculation China’s ongoing efforts to push down iron ore prices will work.

“Iron ore could be stronger for longer - $150 a tonne – but it could just as easily be $65 or $80,” says Tim Gerrard, a natural resources-focused portfolio manager with Janus Henderson.

“Many analysts are using long-term views of iron ore at between $65 or $70 a tonne and even then, BHP looks reasonably valued in terms of net present value, which gives us confidence.”

But copper is the more interesting commodity for BHP, in the eyes of Gerrard.
“We’re only one mine away from seeing dramatic copper shortages globally – if something happens at Escondida (a Chilean copper deposit) or any other 500,000 tonne per annum mine, the copper price could just as easily be $5.50 a pound and we’d suddenly be looking at super profits like the iron ore guys have earned,” he says.

In terms of the risk-reward equation, he finds the copper side of BHP far more favourable.

And China? “It’s a risk, but that’s why we’re not in companies that have got hopeless debt, high costs or just overly-optimistic management. We aim to select companies that can survive the depths of the downtimes, regardless of the source of those risk events,” Gerrard says.

What’s the appeal of BHP?

“This is not the BHP of the mid-90s when it was a quasi-government organisation. It wasn’t an impressive company at that time,” Gerrard says.

“But now, steel and petroleum are gone, and the ‘rats and mice’ (sub-scale assets) have gone into South32."

He believes BHP management has never been better, laying much of the credit for the current culture and corporate philosophy at the feet of Andrew McKenzie, “who wasn’t particularly welcome as the BHP CEO but did a fantastic job.”

“This is not just the work of former CEO Mike Henry, but you’ve got sensible management and processes, management is now ESG- and decarbonisation-aware, and it’s a simplified company,” Gerrard says.

“It’s very large, the assets are run well and they’re going to be run even better. There’s a lot more to come.”

Gerrard says the company is positioned to do very well, with appropriate scale coupled with greater simplicity across the business model. “And unlike Rio Tinto (ASX: RIO), BHP has social value and knows the value of social capital.”

Big cash dividend at a time of COVID uncertainty

A key point here is the strong cash dividend and the absence of a buyback from BHP.

“Management didn’t spell it out, but said things like ‘we want everyone to share…we listen to everyone.’ The determination and the nature of a dividend is not something that just gets spat out of a spreadsheet,” he says.

“This company is more than just doing what the big boys want. They’ve got a broader view of how to help their stakeholders than most companies and in this regard, the large cash dividend will help the retail shareholder base at a time of COVID uncertainty.”

"The market has gone off half-cocked"

The emphasis on more mergers and acquisition activity in the resources space and the ongoing conjecture around what deals BHP might ink is also a common focus of shareholders.

“The market has gone off half-cocked about how quickly they’ll do a big M&A transaction,” Gerrard says.

“But what the market’s missing is the more likely story of a series of bolt-ons, which would allow BHP to grow over a period of time from a pipeline of emerging opportunities, most likely in copper. Some of those could be in the Congo but are more likely to be in Ecuador or Argentina.”

What's ahead for BHP?

In the second half of fiscal 2022, inflationary pressures aren’t likely to trouble BHP much, explains Gerrard, who believes the company can handle the supply chain interruptions. “And the top line is more about high prices which are likely to be lasting,” he says.

And with BHP’s petroleum assets set to be fully divested to Woodside Petroleum (ASX: WPL) by mid-year, he’s also sanguine on the ESG front.

“There are a couple of ESG risks that can occur over the next six months, such as its relationships with indigenous communities around South Australia’s Olympic Dam and Oak Dam deposits,” Gerrard says.

“And there could be more questions over workplace culture because of Rio Tinto but BHP has its own independent initiatives that have been going a while.”

Fortescue Metals Group (ASX: FMG)

At the other end of the spectrum, in terms of being a lower-grade iron ore producer, is the Andrew Forrest-founded miner Fortescue Metals Group (ASX: FMG). On Wednesday, it reported US$2.77 billion in NPAT for the first half of 2022, down around 32% on the same period last year. But Gerrard emphasises the profit figure is still Fortescue’s third-highest interim result ever.

“That profit was enough to support a $2.6 billion dividend, a fantastic dividend result,” he says.
“And the story is not about the profit for this month or the next quarter, it’s whether the market is comfortable, or not, with FMG’s future strategy.”

This future strategy is underpinned by Fortescue Future Industries, the company’s inhouse start-up. As Gerrard explains, there will be some who “violently disagree” with this strategy and want the company to remain an iron ore cash cow.

He notes that Forrest’s vision to produce 15 million tonnes of green hydrogen by 2030 may well be “pie in the sky,” as part of his plan to entirely decarbonise FMG by 2040.

Putting the scale of these ambitions in perspective, Gerrard refers to another company his team knows well, US firm Air Products, which is arguably the world’s best and biggest in the space.

By comparison, Forrest is targeting 60 times the annual output of hydrogen over a similar timeframe, with Air Products world-beating hydrogen project plan looking to produce 250,000 tonnes a year of green hydrogen, beginning 2026.

“It’s pie in the sky, but never underestimate the aspirations of an entrepreneur,” Gerrard says.
“The reality of what seems to be a strange target really doesn’t pass the sniff test. Though I’m not badmouthing FMG, I quite like the strategy because unless they do this, they’ll have a dead iron ore business.”

And if it pays off, there’s every chance Fortescue could begin producing extremely low-cost energy that is in turn used to separate water into its separate elements of oxygen and hydrogen.

“That low-cost hydrogen could spawn a whole new business of taking FMG’s low-grade iron ore, upgrading it a bit and using that cheap energy to turn it into direct reduced iron that gets exported all around the world as a low-carbon product.

China would fall over itself buying that product. Others will also be trying to do this but with all the money it has to throw at hydrogen, FMG is in the ring having a good go at doing it.”

Learn more

Tim and his team invest in high-quality mining, energy and agriculture companies, taking advantage of price shifts between upstream and downstream sectors and across industries. Stay up to date with his latest on Livewire by clicking the follow button here.

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2 contributors mentioned

Glenn Freeman
Content Editor
Livewire Markets

Glenn Freeman is a content editor at Livewire Markets. He has around 10 years’ experience in financial services writing and editing, most recently with Morningstar Australia. Glenn’s journalistic experience also spans broader areas of business...

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