BHP Group: OD expansion set for another reboot

About the author:

Adrian Prendergast
Author name:
By Adrian Prendergast
Job title:
Senior Analyst
Date posted:
20 October 2020, 2:36 PM
Sectors Covered:
Mining, Energy

  • A strong 1Q21 result, outpacing expectations in both iron ore and copper, with BHP Group's (ASX:BHP) Pilbara iron ore, Escondida and Olympic Dam all outpacing our estimates.
  • This has led to upgrades for our estimates for iron ore and Escondida volumes.
  • The latest plan to expand Olympic Dam (BFX) has been shelved, with subsurface drilling in the southern mining area failing to confirm results from surface drilling.
  • We worry Olympic Dam will remain a drag on BHP’s earnings quality and valuation, with BHP appearing wedded to the large-scale/low-return copper mine.
  • Despite OD drag, BHP still boasts robust group FCF yield (9.2%) and value upside (login to view updated target price). We maintain our Add rating.

Olympic Dam still a case of strategy confusion

BHP has shelved the most recent plan to expand Olympic Dam (BFX), with subsurface drilling in the southern mining area failing to confirm results from earlier surface drilling. This showed the large resource was much patchier than expected. BHP will now attempt to pivot its Olympic Dam expansion hopes to focus on the nearby discovery at Oak Dam, which just finished Phase 3 resource drilling.

Our concern here is that BHP appears wedded to a large-scale/low-returning asset in Olympic Dam. We continue to worry that Olympic Dam sits outside BHP’s “capital allocation framework” because it offers scale in a commodity they like (copper).

The reality is copper assets are hard to come by, and when combined with BHP’s history at Olympic Dam, we do not believe BHP will suddenly take a ruthless approach to the big mine’s position in its portfolio despite its long-held poor performance and low potential for improved returns. This leaves us somewhat confused on BHP’s overarching strategy of “value over volume”.

Iron ore impresses despite big maintenance

1Q21 iron ore volumes were -1% QoQ despite major maintenance to Car Dumper 3, with production 100% basis of 74mt (vs MorgansE 69mt vs consensus 71mt), with an impressive performance from the Jimblebar Hub. As a result we have upgraded our 2Q21 iron ore forecast, where similar maintenance is planned for Car Dumper 4. Reservereplacement mine development South Flank remains on track, now 84% complete and expected completion mid-2021.

Copper leaves our estimates behind

BHP’s 1Q21 group copper output beat our forecasts by 12%, with total copper concentrate production of 413kt (vs MorgansE 370kt). This performance was driven by:

  1. Escondida (actual 285kt vs MorgansE 244kt) which kept volumes flat despite having 30% less workforce under Chile Covid restrictions. A bump in grade to 0.85% cu helped, but is expected to still average 0.8% cu through FY21.
  2. Olympic Dam (actual 52kt vs MorgansE 45kt) driven by strong results from both smelter and mining productivity. BHP’s immediate focus on Olympic Dam is getting to more consistent production of ~200ktpa.

Maintain top preference

BHP offers a strong combination of robust bottom-up fundamentals (FCF yield 9.2%, EBITDA margin 55%, gearing 13% and dividend yield 5.3%) and solid top-down market exposures (iron ore and copper prices strong now, with coal and energy resources likely to recover as iron ore moderates).

We maintain our Add rating with a revised target price (login to view updated target price). The key risk to our call remains global economic drivers.

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Disclaimer: Analyst may own shares. The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.

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