About: BHP Group Ltd (formerly BHP Billiton) is a globally diversified natural resources company and one of Australia’s largest listed firms. BHP’s main business units are Petroleum and Potash, Copper, Iron Ore and Coal. The company is dual-listed on the ASX ad the London Stock Exchange and is headquartered in Melbourne.

Why it is in the portfolio: BHP is a very different, much smaller company that it was a few years ago. After a period during the mining boom aimed at volume expansion, BHP has been focused on driving costs lower and shedding unwanted assets in more recent years. These include the spin-off of South32 and the sale of shale oil fields in the US. That sale resulted in a bumper dividend for shareholders, taking the fully franked 1-year forward dividend ratio to over 12%. The market expects this number to drop to 8.5% in 2 years and 6.8% in 3 years, which still represent impressive numbers for any company, let a lone a Materials one. Importantly, this has been enabled by re-positioning the company, as opposed to high commodity prices. Separately (and more recently) the iron ore market has experienced serious disruption, with one of BHP’s main competitor, Vale, having to shut down much of its production due to a dam collapse and further safety breaches. This has translated into higher iron prices (+50%), to the benefit of BHP. However, our holding in BHP is not contingent on such high prices, which are unlikely to be sustainable. BHP remains attractively priced, with a forward EV/EBITDA ratio of 6.1x, almost one standard deviation lower than its long-term average of 6.6x and very far from the heights reached during the mining boom of 9.5x.

Fundamentals: BHP currently trades on a 1-year forward price-to-earnings ratio of around 14x and at around 2.8x price-to-book. BHP’s 1-year forward dividend payout ratio is high (120%) but this is only due to a special dividend. At 2 and 3 years the ratio is expected to drop to 74% and 67% respectively. BHP has a relatively modest level of debt relative to assets (24%).

What could go wrong: Despite turning into a higher quality company, BHP remains materials/mining focused, and therefore still cyclical in nature. Its fate and fortunes tends to be linked to the underlying prices in the commodities in which it operates. As such, investors should be aware that price fluctuations in these underlying commodities can have an impact on the profitability of the business and hence the share price. While BHP is a globally diversified business with operations in many countries, investors should be aware that from time to time single mines or operations may experience singular specific risks which may impact the share price. For example the Samarco dam disaster in Brazil in 2015 in which BHP was responsible for.