Peter O’Connor, Senior Resource Analyst from Shaw & Partners joined James Gerrish, Market Matters / Shaw and Partners, recently to cover a number of topics including his target for BHP: which is the most bullish on the street. Read on for a transcript of his case for the Big Australian to reach $40.

The most bullish in the market

"I am the most bullish in the market and my target price is $33, which is still some way away from the current price of $27.61 as of today, but I've also got a through the cycle objective of over $40 per share. It sounds ambitious. It sounds a long stretch from here, but there are five very significant reasons why BHP will get there, and they've quite clearly laid out for that to happen.

1: History repeating

Firstly, there are some extraordinary parallels to what BHP is doing today and what they did back in the late 90s, and also the mid-80s: a recovery, rejuvenation and restoration of the company back to its classic abilities, and delivery of earnings and then of course of shareholder returns. That's the first step in those parallels we see starting to feed through now, of a new chairman starting, and potentially further changes, and that sets the groundwork for the next four points.

2: Optimisation of the existing assets

Secondly, focusing on the returns of the existing asset base. In short, we hope the company from here doesn't spend another dollar anywhere else other than its existing assets. To put some context around that, if they make their existing asset base, of which 55% doesn't generate sufficient return, lift that to a level, which is regarded to be satisfactory, and it'll unlock about $1.7 billion in additional earnings or about 41% earnings uplift from the current earnings base.

3: The crown jewels

Thirdly, They've got four assets which I deem the crown jewels. One in iron ore, one in metallurgical coal in Queensland, Copper in Chile, and also the conventional oil and gas business. Those four assets have been with the company for decades. They will be with the company for future decades, and they're some of the highest returning assets in the, mining portfolio, globally.

The benefit of turning some of those around, just lifting them to an average margin through the cycle, will help support that previous comment I made of that 41% earnings uplift. Just to give an anecdote to show you how simple it can be, in iron ore we're actually generating substantial returns today. If they take that business and benchmark Fortescue, which is its next-door neighbour in iron ore. If they take their business and meet the target of cost of that company, they will take their cost down to $10 or $11 from the current $13 to $15.

That alone will unlock about US$750 million of additional EBITDA for the company, or about 10% net profit growth. That sounds to be a reasonably doable objective. Particularly because the company's located side-by-side in a straight benchmarking operation, should be quite straightforward. As an anecdote goes, that should be fairly straightforward.

4: Capital management

Fourthly, capital management. What does BHP do with the earnings and the cash that they generate from here? It will be a sizable amount of cash. They will continue the leveraging, and the leveraging stories will it fast. It's now down to a level where they can start to think about giving more cash back, which dovetails well with what they could do in asset sales, and it's about 10 to $18 billion in assets that we think could be sold over the next one, two, three years, starting with shale, which is the most talked about in the market.

And that should be sold within the next year, and we understand overnight there are already two offers out there, or potential interest in shale, but it does feel like it can be contestable in the price, a fair price at least.

That price will go up to some leveraging from here, but more importantly to return to shale. We think BHP is shedding for the buybacks, special dividends, and potentially lifting their ordinary dividend as well. So they'll become quite a substantial capital management story.

5: Sectoral tailwinds

Lastly and most importantly, resource stocks need tailwinds. And right now we've got tailwinds across the board, whether it's global, a macro environment, which is supported, and it's importantly looking to be, all the major economies are moving together in a synchronised way, which we haven't seen for at least the last five to eight years, and that's underpinning commodity prices, which is moving towards one, two, three, five year highs. And that's driving BHP's earnings.

To get to how much upside there is just on those tailwinds, if I read my BHP financial model today, based on current spot prices, my earnings would be over 100% higher than they are in my current forecast. Again, substantial upside, which means more returns for share holders.

Wrapping that together, that's the thesis that I have, which leaves $33 in the next one year. And also, $40 or above, through the cycle."

You can access the full interview here: