Share to Watch: Exposure to variables leaves BHP with forecasting risk
JOHANNESBURG – For some time BHP was in the news for all the wrong reasons. The dam disaster in Brazil haunted them for years. According to the new chief executive appointed this month, BHP is in great shape.
Mike Henry plans to “accelerate” the miner’s productivity push and unlock higher value from its ore bodies and petroleum basins as he prepares to lead the company through a challenging period including a feared slowdown in demand from China.
BHP is one of the world's biggest resources companies. BHP explores, discovers, develops and processes minerals, oil and gas; and is amongst the top producers of major commodities such as iron ore, copper, metallurgical coal as well as oil and gas. Of their revenue, 39 percent is derived from iron ore, 24 percent from copper and 21 percent from coal.
Copper is also an industrial metal and incremental demand for copper is sensitive to GDP growth. However, declining copper reserves threatens copper supply in the future. Possible tight supply of copper will result in increased copper prices due to scarcity of supply.
Copper's desirable properties mean it is one of three primary industrial metals in terms of consumption in the world. Its thermal and electric conductivity and its resistance to corrosion give it wide-ranging uses. New technologies such as electric vehicles and alternative power generation need a significant amount of copper.
BHP’s revenue (70 percent) is geared to minerals whose performance is predominantly correlated to economic growth. Iron ore and copper are highly sought-after metals in the industrial development phase. Uncertainty on global economic growth due to the trade war conflict between China and the US presents downside risks for the world economy.
An economic downturn presents near-term structural headwinds for industrial metal prices as weak business and consumer confidence customarily dampens base metal commodity demand. Iron ore forward prices have slowly started to trade down to normalised levels, at similar levels before the Vale incident at the beginning of 2019. On January 25, 2019, a tailings dam at Vales iron ore mine in Brazil collapsed and released mud flow in the surrounding area of the mine.
Vale announced that the dam failure would impact 10 percent of its iron ore output.
BHP’s portfolio is of mines that are long life, low operating cost, and skewed towards lower-risk countries. It boasts a strong balance sheet, sound cash generation, stable capital expenditure profile and disciplined capital allocation, which supports a high quality and confidence ranking.
BHP is currently trading in line with its peers at a 12 x forward price/earnings ratio, but ahead of its 10-year average. The valuation does not seem to be excessive at current levels, but in the absence of structural tailwinds, it is recommended not to take significant positions in this counter.
BHP is vulnerable to several external variables like commodity prices and exchange rates, which has a substantial effect on group profitability but is not under control of management. This leads to significantly higher forecasting risk. Accordingly, short-term investors should be cognisant of market dynamics and developments when considering an investment in the share.
Amelia Morgenrood is a PSG Wealth financial adviser based in Pretoria. Views are of the author and not necessarily the general view of the entire PSG entity. Bhp shares are held on behalf of clients.