BHP is in a good place as its headwinds are easing

BHP’s commentary on the result was also studded with references to the availability of labour, or rather its scarcity. That’s an issue across the economy, with historically low unemployment levels and the impact of the pandemic on immigration numbers creating a very tight labour market.

Labour accounts for something approaching half of BHP’s cost base, and the absence of near-term solutions to the labour shortages (other than a severe recession) means higher labour costs and therefore inflated total cost bases are probably now entrenched in the resource sector.

The extremely wet conditions and severe flooding across large parts of the eastern seaboard were also a factor in the results, although BHP did well to increase volumes in its core Australian iron ore and coal operations and its Escondida copper mine in Chile, with incremental volumes contributing an additional $US700 million to the result.

In the circumstances, while underlying net profit was down 32 per cent to $US6.6 billion and the interim dividend, at US90 cents per share, is 40 per cent lower than last year’s, the result was a solid performance in challenging conditions.

Even with the lower prices and higher costs, BHP’s suite of assets is low cost and high-returning.

Its iron ore business is, despite an increase in cash costs, at the lowest end of the cost curve and generated an EBITDA margin of 65 per cent. Its copper business had a margin of 44 per cent and its metallurgical coal business achieved 40 per cent. The group’s return on capital employed might have fallen about 10 percentage points, but it’s still an enviable 29.4 per cent.

The finessing of that portfolio continues, with BHP announcing that two more of the Queensland coal mines within its joint venture with Mitsubishi are on the block. The partners have been exiting their lesser-quality coal operations despite the strong prices and outlook for metallurgical coal (at least for the next few years).

This financial year was always going to be a tough one for BHP and its peers, given that China was in continuous and widespread lockdowns during the December half, the war in Ukraine was escalating and driving up fuel costs and contributing to already historically high inflation rates, and some after-effects of the pandemic are still lingering.

With prices recovering, China re-opening, the West’s sanctions on Russia not yet having any further marked effect on energy prices, and inflation, if not under control, then at least edging down in the major economies, the external environment for big resource companies is improving.

For BHP, that will hopefully coincide with its biggest acquisition in two generations of its management.

For most of the past decade, the group has focused on shrinking and simplifying its portfolio and structure, mainly through the spin-off of South 32, last year’s merger of its petroleum businesses with Woodside and the collapse of its dual-entity structure.

Under Andrew Mackenzie initially and, more recently, Mike Henry it has been increasingly and successfully introspective, focused on the detail of its more concentrated portfolio of continuing businesses. It is a tribute to them that BHP’s West Australian iron ore business is now the low-cost operator in the Pilbara.

This year, assuming the acquisition of Oz Minerals (for an enterprise value of $9.6 billion) is successful, it will be deploying its pristine balance sheet (net debt of only $US6.9 billion) and still-strong cash flows to greatly expand its copper and nickel businesses and therefore the proportion of “future-facing” operations and cash flows within its portfolio. Still to come, in 2026, is the first phase of the Jansen potash project in Canada.

As BHP itself said in its commentary, the marginal cost of mining is now markedly higher than it was before the pandemic, which ought to mean higher prices than in past commodities cycles.

The lowest-cost operators should be able to capture higher relative margins in an industry environment where it is the marginal producers, the ones that supply the final tonnes that balance demand, setting the price.

BHP is poised to increase its volumes of high-quality, but low-end-of-the-cost curve and “future-facing” commodities significantly, even as demand for iron ore and coal plateaus. Despite the first-half profit slump as the commodities cycle ran against it, it is in a good place.

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