BHP and Santos confirm cash flow bonanza

The third week of the August rush saw a wave of earnings updates from Australian corporates. BHP (ASX:BHP) was a genuine standout, with outstanding cash flow performance helping to support a pristine balance sheet despite still finding room for a stellar dividend which represented an 8.6% yield for the half and almost 16% for the full year (including franking).

Separately, Santos (ASX:STO) announced a tripling of profits and a near doubling of free cash flow, while Downer delivered a result largely in line with expectations. So why was the market's response so tepid to both results?

In the latest episode, I provide my take on these companies and more in the penultimate episode of the August 2022 4-Minute Monday podcast.

Transcript

Stewart Harris: Hi and welcome to episode three of 4-Minute Monday for the August 2022 reporting season. Joining me to share his latest thoughts as ever is Brad Potter, Tyndall’s Head of Australian Equities.

Brad, in our last episode you touched on the big week that was coming. Of the companies you mentioned – BHP, Santos, Brambles (ASX:BXB), Amcor (ASX:AMC), Downer (ASX:DOW) and James Hardie (ASX:JHX) – who stood out for you?

Brad Potter: BHP – the big Australian – was the standout, reporting an inline result. However, cash flows were substantially better. The net result was that the company only has net debt of $300mn versus $6bn at the interim result. The dividend payout of US$1.75 per share implies a strong yield of 6% for the half, or 8.6% grossed up for franking credits. 

That is an incredible result, and over the full year the dividend was nearly 16% when grossed up for franking credits. 

The company has recently made a cash bid for OZ Minerals (ASX:OZL) to increase their exposure to future facing minerals, such as copper and nickel, that will see unprecedented demand growth as the world moves towards net zero. BHP currently is in a wonderful position with a pristine balance sheet, extremely strong cash flows and a portfolio of tier one assets.

Stewart: Santos announced a tripling of profits and almost a doubling of free cash flow which made for great reading, but the share price finished down on the day. What drove the market’s response?

Brad: Despite an extremely strong result from Santos, driven by elevated oil prices and stratospheric gas prices, the market appeared disappointed by the progress in asset sell downs. Santos has now terminated the Alaskan Pikka oil project and has moved to FID, or Final Investment Decision. Our expectation is that the sell down process will perhaps be reinitiated during construction or first production, meaning Santos won't own as much as it does currently. This is a logical and sensible decision given the volatility in oil markets and the time required for the sell down. The value of the project should grow over time during this process. The sell down of the highly valuable PNG project has been retooled to about 5%, and the company expects to receive a price that is in line with market expectations. Free cash flow generation remains extremely high, and thus the need for asset sales to bring the balance sheet into better shape is not required. 

The stock has materially underperformed peers over the past year and does present as attractively priced.

Stewart: Brad, the result from Downer confirmed some of the challenges for contract maintenance firms finding staff. What did you take from their release?

Brad: The Downer result was largely in line with expectations. However, Downer did provide its first quantitative guidance for the last two years (given COVID). It was arguably conservative as Downer has been hit with additional costs during the past two years with COVID, and now inflation. General labour costs have been mitigated with CPI escalators in their long-term contracts, however there have been additional costs to serve due to COVID that can't be fully recovered. Other costs such as fuel and bitumen can be recovered, but with a lag. 

The market seemed underwhelmed by the guidance given arguably the large weather and COVID impacts should reverse out and Downer continues to have a strong pipeline of work. 

Downer is wonderfully exposed to the massive decarbonisation trend with electricity transmission, recycled road base, transport and hydrogen some of the opportunities that it can take during this incredible transition that's about to occur.

Stewart: We’re nearing the end of the August rush. Who are you excited to hear from this week, and are there any key themes emerging at this stage from this reporting season?

Brad: There’s still a week and a half to go, and this week's results and subsequent meetings with management will be insightful. Both Coles and Woolworths will provide insights to how they're coping with the substantial food inflation, and Woodside will present a very messy result given it is the first post the merger with BHP oil. There is an expectation, however, that they will pay out some of the cash flows generated by BHP oil during the fiscal 2022 result.

Key themes emerging are pretty much as expected prior to the month: conservative guidance, input cost and inflationary pressure, labour shortages, and emerging debt cost increases. 

The impact from the RBA rate rises on the consumer are only just starting to emerge and thus the consumer facing businesses will need to be monitored closely going forward.

Stewart: Well that’s three weeks down – and only one more week to go. Tune in next Monday for the final instalment. until then, stay invested.

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