BHP Stock: Time To Pause The Optimism – Keep Calm & Continue Dripping

Investment Thesis

BHP Group Limited (NYSE:BHP) has certainly rallied upon the rumors of China’s unexpected reopening cadence in early November. Many other iron-ore/copper stocks, such as Rio Tinto Group (NYSE:RIO) and Freeport-McMoRan (NYSE:FCX), have similarly recovered from their previous rut by 31.78% and 19.77%, respectively. This is because the country accounted for an immense 43.07% of the global iron-ore demand at 1.12B tonnes and 53.19% of the global copper demand at 12.5M tonnes in FY2021. Impressive indeed, despite the previous Zero Covid Policy.

In the meantime, China’s reopening may be fraught with challenges, due to the rising COVID/death cases. There may also be irreparable damages since many overseas investors/companies are seeking geographical diversification, significantly worsened by the ongoing Chip wars. Most notably, Apple’s (AAPL) leading supplier, Foxconn, has planned to shift up to 30% of its production capacity to other countries, including India, Vietnam, and Brazil.

Nonetheless, market analysts are already expecting the Chinese economy to normalize by mid of 2023, triggering a flurry of consumer/corporate spending over the next few quarters after three years of nationwide lockdowns. Several government stimulus packages, including 300B Yuan (the equivalent of $43B) for infrastructure investments and 1T Yuan ($140B) for semiconductors, may contribute to this cadence, while also supporting the recovery of the domestic property market. It is no wonder Mr. Market is extremely hyped about the country’s fast and furious reopening, since the latter accounted for 56.24% of BHP’s revenue in FY2022.

The Abrupt Development Has Contributed To The Recovery Of Commodity Prices

BHP YTD Stock Price

In FY2022, iron ores constitute 47.02% of BHP’s revenues, with copper taking second place at 25.74%. Consequently, market analysts have linked its valuations to these spot prices, pointing to the sustained volatility in the stock and the highly cyclical commodity markets alike.

Iron Ore & Copper Prices

The recent optimism surrounding China has also boosted iron ore spot prices by 36.41% and copper spot prices by 10.81% since early November. However, it remains to be seen if the rally will be sustainable, due to the Feds’ determination to tamp down the rising inflationary pressures. The large gap between peak prices in March and today reflects this uncertainty.

98% of all iron ores produced are used to make steel, of which over 50% is attributed to the global housing and construction sector, with the balance comprising automotive, transportation, and infrastructure end-markets. Analysts project that the global steel demand will expand by another 20% by 2050, to cater to the growing population. During the US property boom in mid-2021, iron ore prices consequently rose to over $212 per ton, increasing by over 800% from 2015 lows.

However, the property market in the US is rapidly cooling down, due to the elevated 30Y fixed rate mortgage averaging 6.33%, doubling from 2021 levels. The November CPI is already reporting moderated sequential growth of 0.4% for housing, against August levels of 0.7%. The Feds are also poised to keep raising until a terminal rates of 5.1%, indicating further headwinds in the US property affordability moving forward. This reversal has impacted iron ore prices drastically to $97 per ton by mid-2022 and to $81 during peak pessimism levels in November 2022.

Declining Housing Prices In China

The reduced consumer confidence in China’s property market is not helping matters as well. Domestic property investments have plunged by 20% YoY in November 2022, indicating the steepest decline since 2013, with only 26% of projects successfully sold in thirty major Chinese cities thus far. Therefore, it is unsurprising that home prices have also tragically plummeted by 67% YoY for certain areas in Guangzhou. Combined with the elevated default rate of Chinese real estate bonds, the recovery of Chinese property market will remain uncertain through H1’23.

On the same note, the consumer demand for EVs is a key indicator of the commodity, since EVs require 2.5 times as much copper than conventional ICE vehicles. Unfortunately, EV sales have suffered with a slowing new vehicle Index of 0% in the November CPI, compared to September levels of 0.7%. This is partly attributed to the tightened consumer discretionary spending at a time of rising inflationary pressure. The latter has caused automakers such as Ford (F), General Motors (GM), and Tesla (TSLA) to raise their prices several times in response. The higher production output upon the easing of the global supply chain has also contributed to the increasing supply of unsold new vehicles in the US by 5.8% sequentially and 81% YoY to 1.64M. The contradictory situation has consequently hindered the recovery of copper prices.

The situation is not unique to the US as well, since TSLA has had to offer a 6K Yuan discount to its Chinese consumers, on top of a 4K Yuan insurance subsidy, in order to boost sales. Due to the uncertain consumer demand in China, the company opted to cut production output and freeze hiring temporarily. It remains to be seen if the reopening cadence will result in an increased appetite for autos, as it did in the US and China in 2021. At that time, the former reported insatiable demand for new/used autos by 3.4%/10% YoY, with the latter similarly experiencing a 3.8% YoY growth for new vehicle sales and a 169.1% YoY for new-energy vehicles (the equivalent of EV). Only time will tell, since Xu Haidong from the China Association of Automobile Manufacturers expects to see an impressive 35% YoY growth in the sales of new-energy vehicles in 2023.

In the meantime, the recovery of copper prices may be supported by the ongoing renewable effort within the US and China, since wind and solar energy generation requires up to six times more copper per installed MW. Considering the impact of IRA, many renewable companies such as, First Solar (NASDAQ:FSLR) and Enphase Energy (NASDAQ:ENPH) have reported tremendous growth in their backlogs and long-term supply agreements for the next few years. The optimism is also reflected in their stock prices, recovering by 229.77 and 54.33%, respectively, from the recent bottom in July 2022. The global renewable energy market is expected to grow at a CAGR of 8.6% to $1.99T by 2030, pointing to the positive impact on copper demand and prices moving forward.

In the meantime, market analysts proved to be more bullish, predicting that iron ore prices may rise to $120 and up to $150/ ton by H1’23, assuming a voracious reopening appetite. That would indicate an excellent 35.74% upside, despite the massive recovery witnessed thus far. Consequently, investors with a high-risk tolerance and keen monitoring may be able to execute a profitable short-term trade with the BHP stock. Our advice, however, is to proceed with caution during these volatile market conditions to avoid burning oneself. In the meantime, we encourage you to read our previous article, which would help you better understand its position and market opportunities.

• BHP Group: The Gift That Keeps On Giving – Continue Dripping Ahead

So, Is BHP Stock A Buy, Sell, or Hold?

BHP YTD EV/Revenue, P/E, and Market Cap/FCF

BHP is currently trading at an EV/NTM Revenue of 2.93x, NTM P/E of 12.27x, and NTM Market Cap/FCF of 10.39x, higher than its 3Y pre-pandemic levels of 3.19x, 13.90x, and 10.79x, respectively. The current baked-in premium is also evident compared to its YTD P/E mean of 10.97x. Based on its projected FY2024 EPS of $4.99 and current P/E valuations, we are looking at a moderate price target of $61.22. This also mirrors the consensus price target of $62, indicating the minimal safety margin for those who load up here.

Combined with the abovementioned factors, we prefer to be more careful and recommend waiting for a deeper retracement. Investors should also look forward to the upcoming H1’23 earnings call on 19 January 2023. The management’s forward commentary may prove critical in the stock’s trajectory over the next few months. In the meantime, long-term BHP investors should DRIP accordingly, with $3.42 of dividends per share projected by FY2024.