BHP Group: More moves to make?

About the author:

Adrian Prendergast
Author name:
By Adrian Prendergast
Job title:
Senior Analyst
Date posted:
24 November 2021, 8:30 AM
Sectors Covered:
Mining, Energy

  • BHP Group (ASX:BHP) has signed a share sale agreement (SSA) with Woodside Petroleum (ASX:WPL), with the proposal to merge their two petroleum businesses now binding.
  • There will be no merger relief, with the divestment an FY22 tax event for BHP shareholders. Although BHP will use its franking credit balance to classify the new WPL shares to be issued as a fully franked in-specie dividend.
  • In our P&L we have reclassified BHP’s Petroleum earnings as discontinued operations, in line with how it will report its 1H21 result.
  • BHP’s dividend yield will decline given the smaller earnings base (ex-Petroleum).
  • We now value BHP’s Petroleum assets based on the 48/52 merger ratio.
  • Some hurdles remain, including a vote on the merger by WPL shareholders.
  • We maintain our Add rating on BHP with a revised (login to view) target price.

Event: BHP/WPL sign SSA

The key terms and timing of the merger remain unchanged, with an effective date of 1 July 2021 and expected completion target of Q2’CY22. 

The 48/52 (BHP/WPL) merger ratio has been maintained, with a small tweak being this will be calculated on WPL shares as at the 1 July 2021 effective date and adjusted for WPL’s dividend reinvestment plan (DRP) at the time of deal completion to not disadvantage BHP shareholders.

Merger relief was not able to be obtained on the deal, meaning the issue of new WPL shares to BHP holders will be a tax event for BHP investors in FY22. In our view, something that was unavoidable given the scope of the transaction. Instead, BHP will use its US$16bn franking credit balance to classify the new WPL shares issued as a fully franked in-specie dividend. Shareholder cost bases on BHP holdings will not change as a result of the transaction.

Meanwhile, BHP also agreed to the final investment decision (FID) on the Scarborough project. Estimating a 13% IRR and 6-year payback period, not robust numbers that impress but typical for mega-scale capital-intensive LNG projects.

The reality is often worse, with execution risks dragging budget and schedule and return profiles for LNG projects often negative (as was experienced with Pluto T1).

Analysis: Is BHP shrinking?

BHP has made a number of big moves in recent years, supporting the view that Mike Henry was appointed for his vision, not just his operational chops. BHP has moved decisively to exit coal (ex-BMA) and oil & gas, while entering construction of Jansen (potash). While a strategic exit from some difficult commodities, the divestments have blunted BHP’s growth profile while reducing diversification.

We do not think this is the last move, and expect BHP to continue to move its portfolio to add further base metal growth options. As a base case we expect more acquisitions of development-ready copper/nickel projects (like Norront Resources), while we see more aggressive M&A of existing miners also a realistic scenario.

Forecast and valuation update

BHP has flagged that it will remove its Petroleum earnings from its P&L and will reclassify them as ‘discontinued operations’, so we have moved to do the same. Its Petroleum assets will be reclassified as ‘held for sale’.

The implications of this is lower group earnings used by BHP to calculate its dividend, which we now forecast at US$2.56ps in FY22 (was US$2.98ps). This number has also been partly impacted by a mark-to-market on iron ore prices.

We move our valuation on BHP Petroleum to its implied 48% share of the merged entity, increasing our value on BHP Petroleum to US$21.9bn (from US$15.5bn). 

Post these changes and some model maintenance (changes summarised further) our updated target price is (login to view).

Investment view

We see BHP as best placed to take advantage of current varying commodity cycles and maintain our Add recommendation.


Key risk to our call remains COVID related impacts to commodity demand drivers.

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Disclaimer: 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.

Solid top-line outcome: BAP’s 1Q22 revenue was flat on the pcp, an extremely resilient result given the extent of lockdowns in the period (~70% of stores impacted) and the strength of the pcp (cycling 27% growth). Composition comprised: Trade +2%; NZ -10%; Retail -12%; and Specialist Wholesale +7%. Overall, BAP stated that non-lockdown areas are outperforming expectations. ▪ 1Q22 trade & retail: Trade/Burson revenue was up +2% on the pcp (LFL sales - 1%; cycling 8% pcp); NZ/BNT revenue was down -10% (LFL sales -15%; cycling +4%); and Retail/Autobarn revenue was down -12% (LFL sales -16%; cycling +36%). Within the Retail segment, online sales were +80% on the pcp. Stores percentages impacted by lockdown were: Trade 70%; NZ 100%; and Retail 50%. ▪ Specialist segment results: Specialist wholesale revenue is up 7% on pcp, with Auto electrical/Truckline divisions ‘performing strongly’; and WANO underperforming. ▪ GM pressure expected to be temporary: BAP stated GM was stable across Wholesale and NZ (45% of FY21 revenue); and down ~50bps Trade and Retail (~55% of FY21 revenue), driven by promotional and online pricing in lockdown areas (we assume no margin pressure witnessed in non-lockdown areas). BAP expect margins to revert once lockdowns ease. ▪ The cost base has increased vs pcp, a function of duplicated DC costs (commencement of new VIC DC), and higher group and team member support (covid related) costs. BAP noted FY22 store rollouts and refurbs are on track.

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