BHP Group Riding China’s Steel Wave

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As BHP Group rides China's steel production wave, brokers anticipate the first half result in February will provide an opportunity for the new CEO to outline priorities and opportunities.

-Petroleum now at the lower end of guidance range
-Copper prospects excite several brokers
-Earnings upgrade momentum driven by buoyant iron ore
 

By Eva Brocklehurst

A strong outlook for iron ore and metallurgical coal is providing momentum for BHP Group ((BHP)). Brokers eagerly anticipate the first half result on February 18, which will be the first opportunity for CEO Mike Henry to publicly address the market and provide answers on how opportunities and priorities are being viewed by the company.

Copper production in the December quarter was the main positive surprise compared with broker forecasts, having benefited from record concentrator throughput across the first half that more than offset the impact related to stoppages in Chile.

Copper and energy (thermal) coal production increased 6% and 8% respectively quarter on quarter, while metallurgical (coking) coal rose 17% after major maintenance was completed in the prior quarter.

Nickel production was down -24% but that was because of maintenance at the Kwinana refinery and Kalgoorlie smelter although this is expected to lift production going forward.

Production guidance is unchanged, although petroleum is expected to come in the lower end of the prior forecast range of 110-116 mmboe. This stems from unfavourable weather conditions in the Gulf of Mexico.

There is also some risk to thermal coal guidance in the instance of any bushfire events near the NSW production hub but at this time guidance is unchanged. Smoke and dust have reduced air quality and this did affect volumes in the second quarter.

Cost guidance was unchanged for FY20. Escondida (copper) is running below cost guidance because of higher by-product credits, which UBS suspects relate to gold. An abnormal charge of -US$500m relating to the cancellation of power contracts at Escondida is included in first half estimates. Brokers point out Rio Tinto ((RIO)), which has called out -$200m for its share, will take the charge against underlying operating earnings.

Meanwhile, funds of US$581m have been released to support the Renova foundation in 2020 which will be offset against Samarco provisioning following the dam failure.

BHP Group Versus Rio Tinto

Credit Suisse continues to believe the company's portfolio provides two benefits compared with rival Rio Tinto. These include greater breadth of commodity exposure that helps it to withstand any swings in any particular commodity, and a broader range of opportunities in petroleum and potash.

Shaw and Partners loves both companies and points out they have landed on exciting copper prospects, with the main determinant just how large these turn out to be. BHP Group's Spence growth option is on track for first production in the first half of FY21.

Ord Minnett maintains a preference for Rio Tinto because of its cheaper valuation metrics although acknowledges there is little to differentiate the investment case between the two. Both have good balance sheets, solid returns, a similar free cash flow yield and catalysts from the strength in iron ore markets.

China Steel

Credit Suisse now has a more constructive view about China's crude steel output in 2020, and upgrades the company's numbers to reflect the increase in its forecasts for iron ore and metallurgical coal.

With strong Chinese rhetoric around infrastructure in particular, the broker assumes a 1.6% increase in Chinese steel demand in 2020, although by the second half steel production is likely to slow. This will coincide with seasonally strong supply of iron ore and allow depleted inventory to be somewhat rebuilt.

A similar pattern is expected in 2021. As a result, Credit Suisse iron ore price forecasts are raised to US$90/t for 2020 and to US$80/t for 2021. Metallurgical coal price forecasts are moderated slightly, given the risks around Chinese import restrictions, to US$166/t for 2020 and US$175/t for 2021.

Macquarie calculates the spot price scenario for iron ore is driving around 35% and 50% upside to its FY21 and FY22 earnings forecasts, respectively. That said, the broker's production forecasts for Pilbara iron ore are now below guidance.

Shaw and Partners, not one of the seven stockbrokers monitored daily on the FNArena database, has a Buy rating and $40 target. The database has five Hold ratings and one Buy (Macquarie). The consensus target is $39.65, suggesting -3.6% downside to the last share price. The dividend yield on FY20 and FY21 forecasts is 4.8% and 4.5%, respectively.

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