AU earnings: BHP - the path to profitability

In the realm of commodities and mining, BHP's recent quarterly production results reflect its ongoing pursuit of strategic investments in copper and potash. In this week's Investor Spotlight, we delve into how these developments shape the mining giant's earnings potential and the influence of volatile iron ore prices.

BHP’s earnings performance and context

BHP’s earnings growth over the past three years has averaged 37.57%, surpassing the industry's 13.53% average. The influence of elevated iron ore and coal prices significantly contributed to robust earnings in 2021 and 2022, following the trends of other major iron ore players like Rio Tinto.

FY23 outlook indicated by 4Q23 results

BHP’s FY23 earnings trajectory was largely indicated by its 4Q23 results, announced on 20th July. Consensus views on production outcomes align with management’s FY23 guidance, with Goldman Sachs noting the June quarter's better-than-expected performance in copper and metallurgical coal production, despite weaker coal prices in the latter half of 2023.

BHP daily chart

Commodity price influence

The significance of commodity prices to BHP's earnings is undeniable. Macquarie's assessment projects a 17% decline in FY23 revenues compared to FY22, attributed to weaker commodity prices across iron ore, copper, and metallurgical coal. This has a cascading effect on BHP's financial performance, with a forecasted 35% decrease in Net Profit After Tax (NPAT).

Following the divestment of the Petroleum business to Woodside, the mantle of primary earnings driver is taken up by West Australian iron ore. Macquarie's analysis indicates that this segment is set to represent 57% of EBITDA, up from 54% in FY22.

Copper's increasing EBITDA contribution

With the integration of OZ Minerals, copper's role in BHP's EBITDA composition is projected to rise significantly, increasing from 21% to 26%. Meanwhile, the intricacies of the coal market's price fluctuations and production dynamics are expected to lead to a drop in its contribution from 24% to 16% in comparison to the previous year.

Iron ore and coal's performance

The realised iron ore price for FY23 is reported at US$92.54 per wet metric tonne (wmt), a notable decline from the US$133.10 wmt recorded in FY22, according to BHP's reports. Counteracting the impact of lower copper prices (FY23 at US$3.65/lb, down from FY22's US$4.16/lb) is the expectation that copper sales will mitigate the decline, offsetting a 12% decrease at the EBITDA level.

The Coal division's fortunes underwent a considerable reversal following the robust prices achieved in FY22. BHP's FY23 reports reveal that realised coking coal prices experienced a drop of 25%, and the decline was even more pronounced for hard and weak coking coal, with respective declines of 25% and 15%.

These price dynamics illustrate the intricate balance between commodity values and BHP's financial performance, a crucial consideration for both the company and its investors.

EBITDA by commodity chart

Market consensus forecast chart

Copper and potash shape the future

BHP's strategic vision positions copper as a pivotal driver of future earnings. A concerted and ongoing investment strategy in the group's copper assets, coupled with the integration of OZ Minerals, is anticipated to propel the Copper division's earnings share from its current 24% to a substantial 45% by FY2026.

Goldman Sachs identifies a significant challenge and simultaneously a potential avenue for growth. The endeavor to counteract diminishing copper reserves and grades in Chile necessitates a hefty US$7-9 billion investment in BHP's South Australian copper operations. This strategic move holds the promise of expanding production to surpass 500 thousand tonnes per annum (ktpa) within the next 5-10 years.

Highlighting BHP's considerable copper potential, the broker underscores the company's preeminent position with the largest global copper reserves and resources. These assets, amounting to 40 million tonnes (Mt) of reserves and an impressive 200 Mt of resources, bolster BHP's strategic advantage in this critical market.

Patience required for potash

It's worth noting that meaningful earnings from the potash operations are not anticipated until FY27. While the Jansen project holds great promise, its contribution is a venture that demands investor patience, with substantial returns expected to materialise a bit further down the line.

Incorporating copper and potash into BHP's future strategy underscores the company's dynamic approach to diversifying revenue sources and securing robust earnings streams beyond the immediate horizon.

BHP divisional EBITDA breakdown chart

The crucial role of iron ore prices

BHP's share price trajectory is poised to be significantly influenced by the direction of iron ore prices, intricately linked to the performance of the Chinese steel market. The Chinese real estate landscape, exemplified by the financial woes of the Country Garden Real Estate group, mirrors the Evergrande debacle.

Anticipated trading suspensions and unexpected losses in the real estate sector, along with a slower-than-forecast post-COVID recovery in China, compound the challenges. Heavily indebted property developers grapple with both sluggish demand and substantial debt burdens.

Speculations about additional Chinese government stimulus are brewing, yet pinning hopes on an immediate increase in iron ore prices might be overly optimistic.

Key focus

As BHP approaches its forthcoming report, key focal points include the anticipated rise in the cost outlook, forecasts for capital expenditure, and the dividend. The intricate interplay of these factors will significantly shape investors' perceptions of the company's performance and its financial health.

Insights from Goldman Sachs and Citigroup

Goldman Sachs emphasises the significance of BHP's iron ore and copper production in the fiscal year 2024, forecasting Pilbara iron ore production in the range of 282 to 294 million tonnes and copper production at 1.72 to 1.91 million tonnes. However, the outlook for metallurgical coal and nickel appears to be more subdued.

Citigroup's cautious stance centers on inflationary pressures on costs, reflecting a conservative approach aligned with the lower end of consensus earnings expectations.

Analyst ratings and price targets

Refinitiv's analysis of analyst sentiment reveals a distribution of ratings, comprising 3 Strong Buy ratings, 6 Buy ratings, 8 Hold ratings, and 2 Sell ratings, with an additional 1 Strong Sell rating. A comprehensive assessment of the mean share price target underscores expectations at $45.26, while the FNArena target average price closely converges at $44.133. These figures are juxtaposed against the current share price of $45.73.

Evaluation of free cash flow by Macquarie

Macquarie's evaluation sheds light on BHP's free cash flow yield, foreseeing a range of 6% to 7% for fiscal years 2024 and 2025. This projected yield amplifies to a promising 8% to 10% when considering spot commodity prices, reinforcing BHP's potential for robust cash generation and financial resilience in the near term.