A broadly based leap in commodity prices has given way to greater divergence and volatility in the world’s demand for base metals. In the face of sluggish demand from the West and a shaky prognosis for the Chinese economy, BHP’s shares have struggled for direction over the past 12 months.
Its latest half-year numbers contained few surprises: revenue was up 6 per cent to $27.2 billion and ahead of consensus, largely thanks to higher realised prices for iron ore and copper, its core products. Yet that did little to calm investors’ jitters.
A $2.5 billion impairment relating to its nickel operation in Western Australia had been pre-flagged, sending pre-tax profit for the miner down to just shy of $4 billion, compared with $10.1 billion over the same period in 2022. That, though, has left shareholders questioning whether the operation will be wound down altogether.
The Australian nickel industry has been hit by a glut of Indonesian supply, which has surpressed prices. Mike Henry, BHP’s chief executive, has said that operations and capital spending are being reviewed. The impact on the market is expected to continue until the end of the decade, albeit with the damage to BHP being limited by the relatively small contribution of nickel to the group’s overall production.
The demand outlook for iron ore and copper is of more concern. The average realised price for the former rose by just over a fifth last year to almost the level achieved in 2021, when a sharp recovery in demand rapidly outpaced supply in the wake of the pandemic. That offset a slight reduction in output and pushed underlying earnings before interest, taxes and other items up by 27 per cent to $9.7 billion.
Demand from the Chinese infrastructure and automotive industries has helped to offset a slump in the steel-hungry property construction market. Nevertheless, the outlook from the pivotal steel market remains “cautious and conditional”, according to Henry, uncertain until the efficacy of policy support from Beijing becomes clearer.
Demand in the West has been softer than expected, too, as the impact of higher interest rates and inflation have weighed on consumption levels, the “lagged” impact of which is expected to continue throughout the year. So is the impact of cost inflation, largely relating to wages.
In light of those challenges, an enterprise value of 5.6 times forecast earnings before interest, taxes and other items, at the higher end of the five-year range, does not look compelling.
There will be growing demands on BHP’s capital over the coming years, including the Jansen potash project in Canada, its largest exploration project. Capital expenditure is set to rise from $6.7 billion last year to about $10 billion for the next two years and to stay just north of that level in the medium term.
Dividends have peaked as far as the latest commodities supercycle goes. A dividend of 72 cents a share has been declared in respect of the first six months of the year. Analysts have forecast a payment of almost 123 cents a share this year, which would represent a less attractive dividend yield of 4.2 per cent at the present share price.
The enduring fallout from the Samarco dam disaster also remains a risk to BHP’s bottom line. Provisions in relation to the environmental catastrophe were increased by $3.2 billion last week, after a court in Brazil ordered BHP, along with Vale, its Brazilian peer, to pay billions of dollars in “moral damages”.
BHP has said that it intends to appeal against the decision, a process that could take about two to five years. It takes the total amount set aside by BHP to $6.5 billion, but the total amount being sought by Brazilian federal prosecutors is $31.4 billion, roughly £24.8 billion, alongside a £5 billion class action in Britain.
Advice Hold
Why The present valuation does not represent an attractive entry point
Dunelm
Dunelm is one of only a few homewares retailers to have enjoyed continued success since the pandemic, when people used lockdowns to refurbish their living areas (Isabella Fish writes).
While its rivals have reported a slowdown in sales, Dunelm has achieved growth. According to Nick Wilkinson, its chief executive, that is because the value-led retail chain has been “able to appeal to different age and economic groups”.
Sales at the Leicester-based company rose by 4.5 per cent to £872.5 million in the 26 weeks to December 30, driven by volume rather than price increases. Volumes were up 6 per cent thanks to market share gains in the homewares and furniture markets.
Discount retailers have thrived in the cost of living crisis as shoppers trade down to cheaper items. GlobalData gave the British discount retail market a value of £46.9 billion in 2022 and predicts it will have a compound annual growth rate of more than 4 per cent until 2027, which should aid the likes of Dunelm.
To build on demand, Dunelm plans to open more stores. It wants to open its first shops in the inner boroughs of London after it reported the highest rate of growth in the capital at the end of last year. That could be a risky move given London’s sky-high rents, but Wilkinson is adamant that he will open new shops only in profitable locations.
Cash generated by the business is plenteous, with free cashflow of £91.1 million over the first half of the year. That has kept Dunelm in a net cash position of £6.2 million.
So why have the shares fallen by 7 per cent over the past year? They trade at just over 14 times forward earnings, below a historical average of 16 and way below their pandemic peak of 29. That is likely because profits have fought against foreign exchange rates and increased freight rate tailwinds. There are signs of profit improvement, however, as Dunelm kept “a firm grip on input costs and inventory levels”. Profit before tax rose by 4.8 per cent to £123 million during the first half.
A £71 million special dividend of 35p per share is set to be paid, down from 40p a year before, with another return possible come full-year results, should business hold up.
Advice Buy
Why Shoppers are likely to remain focused on value
