Copper has had a volatile year in 2022. Bears point to the slowing economy and the way copper prices have sold off since April as signs that a cyclical decline is imminent, while bulls claim that long-term demand from the energy transition will more than make up for slowing construction.
However, I would argue that both the bears and the bulls are correct. In fact, the near-term downturn in copper prices will likely worsen the copper shortage industry experts are expecting to develop in a few yearsâ time. Blinded by short-term troubles in the economy, investors and traders are weakening their stance on copper, which discourages the development of new projects. Rising demand and underdevelopment is a recipe for a supply crunch to emerge, causing bidding wars for available supply.
The recent decline in copper prices has led mining giants like Newmont Corp. (NEM, Financial) and Freeport-McMoRan Inc. (FCX, Financial) to shelve plans for investing in new projects, even as they warn that a massive global shortage will emerge for the red metal, as their cost-benefit estimates see copper prices as being too low to justify expanding production at this time.
âWe'll look back at 2022 and think, âOops,ââ John LaForge, head of real asset strategy at Wells Fargo (WFC, Financial), said. âThe market is just reflecting the immediate concerns. But if you really thought about the future, you can see the world is clearly changing. It's going to be electrified, and it's going to need a lot of copper.â
While most copper stocks should eventually benefit from higher copper prices after the near-term downturn, one that has really caught my attention is BHP Group Ltd. (BHP, Financial), an Australian miner of copper, iron ore, nickel, metallurgical coal and potash.
What makes this company unique is it focuses on the commodities the world needs to decarbonize and sustainably grow. BHPâs long-term outlook is hard to come by in an industry that is typically focused only on the near term, which could give it a valuable edge in the years to come. Management also appears to be shareholder-oriented and as long as commodity prices do not enter a steep long-term decline, the stock looks undervalued at current levels.
BHP Groupâs business and strategy
BHP Group is investing heavily to expand its copper, nickel, iron and potash operations and secure long-term exploration partnerships. These commodities are essential to everyday life, global economic growth and the energy transition. Copper is used heavily in electronics, nickel is a key ingredient in the lithium-ion batteries used in electric vehicles, iron ore is integral to steel-making and potash is a widely-used fertilizer.
The company has an estimated 41.1 million tons of copper reserves. Most of its copper mines are located in Chile, but it has one in Australia as well. There is very little danger of these operations being impacted by geopolitical tensions, which is a major positive. Exploration for new copper targets continues.
Nickel exploration also continued in Canada and Australia in fiscal 2022. This metal is a key component in EV batteries, but the world will have to ramp up its nickel production in order to produce EVs at scale because existing nickel demand for industrial applications is not just going to go away, even if it decreases temporarily due to a recession.
Iron is not expected to demonstrate the same kind of growth as copper and nickel going forward, and as one of the most abundant elements in the earthâs crust, there is plenty of competition in this market. Nevertheless, iron forms the backbone of the developed worldâs infrastructure; the world uses 20 times more iron (in the form of steel) than all other metals put together.
Like iron, Potash is not expected to have the same kind of demand growth as copper and nickel, but even so, as the world population increases and over-farming continues depleting the nutrients from topsoil, potash will always be in demand. BHP has completed the production shafts for its Jansen potash project in Canada, and first production should begin in 2026.
Putting together BHPâs four main products, copper and nickel are where the bulk of the growth prospects lie, while iron and potash are more susceptible to high competition levels and the dramatic downsides that commodity prices can exhibit depending on the economic situation. Potash production has not yet begun; this segment is still pre-revenue until 2026 by the companyâs estimates. Iron ore makes up the bulk of revenue; this segment contributed $34.4 billion in revenue in full fiscal 2022, followed by copper with revenue of $16.8 billion and nickel with $1.6 billion.
Exiting fossil fuels
Even as many peers have been cutting their exploration budgets and shelving new projects, BHP has still been investing in growth, which is due in part to the move to exit most of its fossil fuel businesses.
On June 1, BHP merged its petroleum business with Woodside Petroleum (ASX:WPL). It also completed the sales of its interests in the BMC and CerrejoĚn coal assets, though it decided to retain and operate the New South Wales Energy Coal business until mine closure in 2030, motivated by its commitment to metallurgical coal used in steel making.
Company outlook and guidance
According to its fiscal 2022 earnings report, BHP expects China to emerge as a source of stability for demand in the next year due to policy support. At the same time, it expects to see a slowdown in advanced economies as monetary policy tightens, inflation keeps going strong and Europe deals with the energy crisis brought about by the Russia-Ukraine war and resulting sanctions.
The company says the tight labor market remains a challenge as Covid-19 infections continue to occur in the communities in which it operates. Developing nation Chile has had limited vaccine access, and Australia saw its big wave of Covid-19 cases in the first half of 2022 (previously, strict lockdown policies kept cases low).
In terms of guidance, BHP does not provide earnings or revenue guidance because commodity prices have too much uncertainty, but it does provide guidance for production. The company expects its copper production to increase between 4% and 16% in fiscal 2023 versus fiscal 2022. Nickel production is expected to rise in a range of 4% to 17%, while iron ore production should remain mostly flat with a guidance range of -2% to 3%.
Valuation and dividend analysis
The below charts show how BHPâs stock price has roughly correlated with the prices of its main commodities, iron ore and copper, over the years:
This trend is what we can realistically expect in the future as well. Commodity stocks are at the mercy of market prices. Any relative outperformance compared to peers is typically due to factors such as ramping up production at the right times, better operational efficiencies, good fortune on the exploration front, etc.
After copper prices hit an all-time high of $10,674 per ton on March 4 due to the Russia-Ukraine war, they have dropped to around $7,662.50 per ton as of this writing, though research agency Fitch Solutions believes persistent supply issues will keep prices supported around an average of $7,500 per ton in 2022 and $8,800 per ton in 2023.
The iron ore outlook is less hopeful. ANZ Research forecasts iron ore prices to trend lower to an average of $105 per ton in 2023 and $95 per ton in 2024, driven by reduced steelmaking in China and greater output from Brazil.
Referring back to the above charts comparing BHPâs stock price to iron ore and copper prices, we can see the stock is currently trading around the same levels it was when iron ore prices were $80 to $90 per ton and copper prices were $5,500 to $6,300 per ton. Thus, the stock appears undervalued based on historical valuation levels.
Moving on to the dividend, since BHP has had a record year in 2022 and also sold off its petroleum business, it shared the profits with shareholders, resulting in a trailing 12-month dividend yield of 13.48%. If both production and prices can be around the same level again in a year or two, we might see similar dividends, though we cannot count on it since this is a commodity stock we are talking about.
Looking back through the companyâs dividend history, we see that semi-annual dividends were typically around the low-to-mid $1 range since 2011, with the exception of a period of weakness in 2016 that brought lower profits and a change in dividend policy to lower the minimum shareholder payment to 50% of underlying attributable profit. This policy change was made to preserve the balance sheet in times of crisis.
Takeaway
BHP Group is a long-term-oriented and shareholder-focused mining stock with a focus on a sustainable future. The macro environment may not be supportive of strong increases in its main commodity prices in the short term, with some weakness expected in iron ore, which is why BHP is focusing expansion efforts on copper, nickel and potash. The long-term demand outlook for copper especially remains strong, with shortages expected in a few years that could drive prices up.
Overall, even when we consider the potential for an economic recession, BHPâs stock looks undervalued at current levels. Investors should still beware that if we do see a global recession, though, this stock will likely enter freefall, which is the main reason for the current discount. Thus, while I think BHP remains a no-brainer in the long run, the risk associated with this stock is still astronomically high for new investors at the moment.
