You’d think investing in a company that looks nailed-on to pay record returns to shareholders would be a no-brainer, but the market has placed a fairly unremarkable enterprise value on BHP, one of its powerhouse miners. That might be an acknowledgment that the blistering surge in iron ore prices that has greeted the rebound in demand for the steelmaking ingredient is not here to stay for much longer.
A rocketing iron price lit the fire under BHP’s profit recovery this year, accounting for more than two thirds of earnings before interest, tax depreciation and amortisation during the first six months of the year. A recovery in demand and a tightening in supply amid pandemic disruption to mining operations has given the commodity a scarcity value.
The company is stepping up production to feed this bullish market. Over the 12 months to the end of June, it nudged the volume of iron ore output 2 per cent higher, yet the average price realised for the commodity was 69 per cent above the previous year. Copper prices have followed a similar path.
The result has been a flood of cash. Free cashflow jumped almost 40 per cent in the first half of the year and analysts have forecast $17.1 billion for the year, more than double the 2020 level. So dividend expectations are, rightly, high. The market consensus forecast stands at $3.01 a share for this year and $3.09 in 2022, which at BHP’s share price offers investors a stunning potential dividend yield of 10 per cent this year. These cashflows should give it enough room to keep debt at the lower end of the $12 billion to $17 billion target range. And miners have eschewed splurging on acquisitions and big projects, as was the case in last commodities boom a decade ago.
This has helped BHP to secure its place as the most valuable company listed in London, ahead of Shell. It has a dual-listed company structure comprising two parents — BHP Group Plc, listed in London, and BHP Group Limited, in Australia — which means that it doesn’t have the largest weighting in the FTSE 100.
So are investors being stingy in attaching an enterprise value of only 4.8 times forecast ebitda this year? The answer partly lies in whether you believe the booming market for iron ore and other commodities constitutes a supercycle or a return to pre-pandemic norms for demand.
Analysts at Liberum think the latter. According to Tom Price, the broker’s head of commodities: “We don’t have a paradigm shift here.” There is also China’s pledge to curb steel production and plans to cut carbon emissions. China is by far the biggest consumer of iron ore imports.
For some investors, the heavily polluting nature of the steelmaking process and the memory of the 2015 Samarco dam disaster in Brazil understandably make the stock a no-go. Environmental, social and corporate governance risk naturally remains present.
Other uncertainties remain. While Glencore, a fellow London-listed miner, has agreed to acquire BHP’s 33 per cent stake in the Cerrejón coal joint venture in Colombia, there is a question mark over whether it will find a buyer for, or demerge, its remaining thermal coal assets and lower-quality coking coalmines in Australia — and at what price. Investors are also awaiting the fate of its Jansen Canadian potash project, which would cost about $5.7 billion to complete.
BHP and its rivals Anglo American and Vale, of Brazil, suggest that the supply of iron ore will not increase much in the coming months. Longer-term growth drivers are harder to pin down for BHP, but investors stand to bank impressive immediate returns.
ADVICE Buy
WHY Immediate supply constraints and demand return leaves BHP cashed-up to deliver high dividends this year and next
CVS
British companies have targets on their backs at present, but historically CVS has been more predator than prey. In a consolidating industry, snapping up smaller practices has been the core driver of the veterinary services group’s growth strategy.
Yet it was a rebound in sales from existing practices that caused management to, yet again, raise guidance for its earnings before interest, tax and other charges, which are expected to beat market forecasts. Like-for-like sales over the 12 months to the end of June were 17 per cent ahead of the year before, as the removal of lockdown restrictions allowed more trips to the vet. Analysts at Peel Hunt have increased profit forecasts for this year and next by 2 per cent and 8 per cent, respectively. That leaves them well above pre-pandemic levels.
The group, the second largest player in its sector in Britain, is not reliant on bolt-ons to pump up sales. Whether short-sighted or not, a lockdown boom in pet ownership among those no longer tied to the office has increased the need not only for veterinary treatment but also ancillary services and products such as pet insurance. Pets at Home, the retailer, estimates that pet ownership has increased by 8 per cent over the past year.
For CVS, which also owns referral hospitals and provides insurance, pharmacy and even crematorium services, there are up-selling and cross-selling opportunities aplenty.
Importantly, its balance sheet does not look overstretched, which paves the way for it to continue its acquisitive strategy. Net debt was just over £51 million at the end of June, which management expects to equate to an ebitda multiple of less than one.
A perceived “stability of growth” has led to high multiples attached to companies in the sector, according to Allan Smylie, of Davy, the broker. IVC Evidensia, CVC’s larger rival, was valued at €12.3 billion, or 90 times ebitda for 2020, in its February funding round.
CVS’s enterprise value is less toppy at 21 times 2020 ebitda, falling to a multiple of 18 on a forward basis, which does not look expensive by historic standards. The hunter may become hunted.
ADVICE Buy
WHY Consistent earnings upgrades leave shares with an undemanding valuation
