Coal and petroleum drive BHP's record first half

BHP Group (ASX: BHP) delivered a record first-half net profit, supported by strong prices. Adjusted net profit after tax rose 77% to US$10.7 billion, or US$2.11 per share, in the first half of fiscal 2022. At the operating level, underlying EBITDA of USD 21.4 billion was up 46% on the same period last year. The main drivers were a near US$3 billion higher profit from coal and about US$2 billion from petroleum, thanks mainly to higher prices for both. The result overall met our expectations, and we make only minor changes to our forecasts. We expect a full-year net profit after tax of US$19.6 billion, or US$3.86 per share in fiscal 2022.

We make no change to our fair value estimate for BHP and the shares trade at just over a 20% premium to our fair value estimate. We think this reflects high prices for coking coal, iron ore, and to a lesser extent copper, which we think are unlikely to sustain. BHP is enjoying a cyclical recovery in commodity demand, with supportive fiscal and monetary policy boosting demand and supply impacted by some disruptions due to Covid-19.

There is some optimism that China will provide support for demand as it responds to slowing GDP growth and property development wobbles. However, we see the challenges facing China's property developers as a symptom of excesses. With most of China's population now in cities, the long-term rate of urbanisation is declining. This portends lower demand for new housing and construction, which is not reflected in the price of iron ore or coking coal, nor the shares of BHP.

BHP said it would look to expand its iron ore operations incrementally to more than 300 million tonnes a year, from current levels around 285 million tonnes, through incremental optimisation projects. At this stage, the company is not focused on a major expansion, though says it could if the market demanded it. Incremental volume growth is an option we had assumed would be available to BHP, and likewise other key peers such as Fortescue and Rio Tinto, so we make no changes to our longer-term volume forecasts.

BHP is in a very strong financial position with net debt of less than US$7 billion at the end of December 2021. Free cash flow in the half nearly doubled to US$9.7 billion compared with a year ago. The company has revised its net debt guidance range to US$5 to US$15 billion after considering the planned disposal of petroleum. While it could be argued the guidance range is overly conservative, particularly in the context of the current favourable environment, we think it makes sense to err on the side of caution. Commodity prices are cyclical, and BHP is still a relatively capital-intensive business.

We also think it makes sense for BHP to remain disciplined with capital and to return most of the cash flow to shareholders. To this end, the US$1.50 per share fully franked interim dividend represented a near 50% increase on last year's interim and just over a 70% payout of adjusted net profit including petroleum.

On Tuesday, BHP was as much as 2% higher in the wake of its earnings but closed lower by less than half a per cent to $48.18.

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