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Morningstar | Dividends the Likely Focus of BHP’s Fiscal 2019 Result, AUD 31 FVE Retained

The strong iron ore price is the dominant driver of no-moat-rated BHP Group’s share price. As with our recent review of Rio Tinto, it’s the key reason we see BHP shares as overvalued. That said, BHP is not as expensive as Rio Tinto given the lower relative exposure to iron ore and the importance of oil to BHP’s earnings and fair value estimate. We are more positive on the outlook for oil given the current price is not excessive, unlike iron ore.

We retain our AUD 31 per share fair value estimate for BHP. Fiscal 2019 production generally modestly exceeded our forecasts, with the exception of coal which was a touch weaker. Petroleum was a standout with output 3% ahead of our full-year forecast, exceeding guidance. However, lower than expected price realisation for iron ore disappointed. BHP also expects the effective fiscal 2019 tax rate to be at the upper end of the 33% to 38% guidance range, versus our prior forecast of close to the low end. Coal operating costs are also a minor near-term earnings headwind. Taken together, we’ve lowered our fiscal 2019 adjusted earnings forecast to USD 2.18 per share from USD 2.55 previously. Production guidance for fiscal 2020 was broadly as expected and earnings forecasts for the next four years are little changed on average. Lower fiscal 2019 earnings are not material to our fair value estimate.

High iron ore price forecasts, driven by the time taken for Vale to resolve its production issues, means we expect iron ore to make up 55% of BHP’s group EBIT to end fiscal 2023. But strong demand from China and Vale’s production issues are unlikely to persist. For these reasons, BHP’s share price is elevated. We expect excess cash to be paid to shareholders as dividends, rather than share repurchases. Full-year dividends should total around USD 2.60 per share, including the recent USD 1.00 special. The USD 1.60 of ordinary dividends in fiscal 2019 equates to 78% of adjusted earnings.

In the absence of a significant acquisition, which we think is unlikely in the near to medium term, BHP should be able to maintain a high payout ratio. We’re forecasting approximately 80% of underlying earnings to be repaid as dividends to fiscal 2023. However, our expectation for the iron ore price to fall means ordinary dividends are forecast to fall from USD 2.10 per share in fiscal 2020 to USD 1.30 in fiscal 2023, mirroring our expected decline in earnings.