Is BHP still the “go-to” in Australian Resources?

James Gerrish

Market Matters

BHP has endured a tough time after reporting both earnings and a company restructure this week, firstly let’s look at a quick summary of the news, there was plenty of it:

Earnings

  • EBITDA came in as expected but NPAT was a -2.2% below analysts targets obviously some very impressive / huge numbers with revenue a colossal $60.82bn but probably overall a net miss.
  • They beat with their dividend by ~4% putting the stock on an estimated yield of ~9% over the next 12-months.

Restructure

  • BHP is undergoing a massive petroleum demerger which will eventually deliver a huge dividend windfall – this will take time!
  • Once complete BHP’s oil and gas business would merge with Woodside, and WPL will issue new shares to be distributed to BHP shareholders.
  • The business has approved a huge $5.7bn potash development plan in Canada heralding a new direction for the mining goliath.
  • The company is also going to “unbundle” its dual listing and become one Australian corporate entity, I suspect most subscribers saw it this way anyway – I like this KISS move which should offer enhanced strategic flexibility benefits.

Clearly a lot of moving parts in the BHP investment thesis at the moment. Firstly, the second-highest earnings ever make for some impressive headlines as does US$10bn coming back to shareholders as dividends in September. Although an overall excellent result it’s important to consider where to moving forward against the backdrop of declining growth in China, it promotes the question – “is this the peak.” Secondly, the petroleum demerger option is a big step in BHP’s slimming down the process – another ~$15-20bn of returns to shareholders potentially but a truncated earnings profile ex-petroleum. Hence, the third item, the looming potash investment seems an inevitable, albeit sensible, logical, strategic and hopefully fortuitously well-timed outcome.

We like the direction that BHP is heading under the Chairman, Ken Mackenzie, and CEO Mike Henry. The continued portfolio streamlining, the clunky corporate structure unbundling and the pivot to future-facing commodities (potash) looks sensible, strategic and logical to us. Slowing global growth will invariably be a headwind for the sector and by extension BHP but we believe there is now fresh news to keep a net positive focus on BHP. Importantly, the stock will become less of a “sell” for fund managers moving to an ESG focused mandate.

Short-term BHP looks destined to slide back towards its June low, similar to our “best guess” for the S&P500 but we should also remember it’s going to pay a $2 fully franked dividend next month, the equivalent to ~5% at today's level. I wish MM were light on BHP across our portfolios as we would be looking to buy weakness but at this stage, I would call it a bullish hold.

MM is looking for a test of Junes low for BHP i.e. over 10% lower 

Iron Ore (CNY/MT)

Iron ore has now corrected ~40% from its May high, nothing slow about this bulk commodity. If MM had been short we definitely would be square the question now, 'have things gone too far?', we believe so but no there are no signs of a low at this stage.

MM is neutral/bullish iron ore under 800 CNY/MT 

Today MM has briefly looked at our 4 alternatives to BHP in the Australian market.


1. RIO Tinto (RIO) $113.69

RIO has followed the mining sector and especially the iron ore price lower over the last 2-months – on a standalone basis it is 17% below its July high but it has paid a juicy $7.60 dividend along the way.

We prefer BHP as an overall investment moving into 2022 but as an aggressive play for traders, good risk/reward is around 5% lower, potentially very soon!

MM likes RIO ~$108 


2. Fortescue Metals (FMG) $21.45

Not surprisingly FMG has trod a similar path to RIO falling ~20% from last week’s high – in this case, its forecast to pay an impressive dividend in September, after reporting later this month. Again we like FMG ~8% lower but we have changed our stance towards iron ore more towards selling the rallies as opposed to buy the dips hence again we prefer the more diverse BHP to FMG. However, for the dividend hungry readers, any drop under $20 looks exciting in short term, it's even catching our eye as a way to add some alpha into Christmas.

MM is bullish FMG short-term under $20 


3. Woodside Petroleum (WPL) $20.29

An easy one here, MM hasn’t liked WPL for a while and the news around BHP’s demerger doesn’t change our view. While yesterdays 1H21 result showed the company back in the black, the combination of lower production guidance and higher costs have us preferring Santos (STO) for energy exposure.

MM has no interest in WPL 


4. OZ Minerals (OZL) $22.01

OZL delivered an excellent first half result this week but the stocks struggling to react under the pressure of a falling copper price, they even threw in a nice although small 8c special dividend. We continue to like OZL, over the past 6 years the company has enjoyed growth, earnings and commodity price tailwind plus the companies track record over the same period in terms of guidance & delivery has been “best in class”. The stocks almost become a victim of its own success and is not particularly cheap ~$22, following the pullback in copper, but we remain keen accumulators into further weakness as we believe in sticking with quality ~95% of the time.

MM remains a keen buyer of OZL ~$20 

The Bottom Line

  • MM likes BHP and OZL as core portfolio holdings, both stocks are approaching exciting entry levels for those that do not hold them.
  • MM is likely to increase our weighting towards OZL into further weakness
  • FMG looks like an excellent short-term opportunity under $20 as Iron Ore becomes ‘over sold’.
  • RIO is an aggressive trade ~$108

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James Gerrish
Portfolio Manager
Market Matters

James is Portfolio Manager & Primary Author at Market Matters, a daily investment report with over 2500 subscribers that offers real market insight. He is also Senior Portfolio Manager within Shaw and Partners heading up a team that manages...

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