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Morningstar | Stronger 2H Needed for BHP to Meet Production Guidance

BHP’s production is largely tracking in line with our expectations for fiscal 2019, albeit output will need to be weighted to the second half for guidance to be met. BHP maintained volume guidance for all key commodities with the exception of copper, which increases after the sale of the Cerro Colorado mine did not proceed. BHP also maintained fiscal 2019 cost guidance for all major assets, but this relies on a much better second half. The first half was impacted by unplanned outages at Olympic Dam and Spence, which saw about 70,000 tonnes of copper output lost. The much-publicised Pilbara train derailment reduced iron ore volumes by four million tonnes.

On the productivity front, BHP is facing some challenges. BHP says the interruptions had a USD 600 million impact on productivity. The company had previously guided to USD 1 billion of productivity gains in fiscal 2019, but that target is now under review. The USD 1 billion guidance was already lowered from a prior goal for USD 2 billion of gains by end fiscal 2019. However, in terms of the impact to near-term earnings, continued favourable commodity prices are so far making up for the shortfall.

With production broadly tracking our expectations, we maintain our AUD 25 per share fair value estimate. The sale of the U.S. Onshore assets is now complete, and BHP’s portfolio is simplified. This should help the firm to continue to focus on productivity and improving asset stability. We have factored in meaningful productivity improvements over the five-year forecast period, consistent with BHP’s and the broader industry’s focus. Despite this, we continue to see the shares as overvalued reflecting our lower forecast commodity prices, particularly for iron ore and coking coal. We still expect China’s steel demand to decline and for scrap to account for a greater proportion of supply. This will be enabled as China’s stock of steel matures and steel in obsolete cars, machinery and buildings is ultimately recycled.

BHP has completed its USD 10.4 billion of shareholder returns from all of the shale assets sale proceeds. Despite the cash outflow, the balance sheet remains in good shape. BHP explicitly targets debt of USD 10 to USD 15 billion through the cycle. We expect the company to exit fiscal 2019 with net debt near the middle of the range and currently forecast a further decline to about USD 5.4 billion by end fiscal 2020. This does not factor in any additional share buybacks or special dividends, but given near-term cash flows, more look possible until the end of fiscal 2020.

BHP is well placed financially to make acquisitions; however, our preference is generally for excess cash to be returned to shareholders. We forecast total debt/EBITDA of less than 1.0 for our five-year forecast period and for the company to be net debt free by mid-2022. BHP intends to keep debt at relatively low levels at this point in the cycle, but importantly can increase debt to invest countercyclically when conditions worsen. While external conditions are generally favourable for miners now, that will eventually change, and it’s important BHP retains the ability to invest countercyclically. Limited net debt is appropriate now given the maturity of the current cycle.

BHP’s first half fiscal 2019 profit will be impacted by a several items including a USD 222 million higher exploration expense, a USD 100 to 150 million impairment at Olympic Dam and an approximate USD 300 million after tax loss on the discontinued Onshore U.S. operations. The company also expects an impact from the Samarco disaster but is yet to finalise the number. On balance though, the items are relatively small. Cash flow will benefit from the proceeds from the sale of the shale assets.