What to focus on investing in BHP shares?

$BHP Group Ltd (BHP.AU)$ has come a long way since its humble beginnings as two small mining companies in the mid-1800s, and is now a global leader in the diversified resources industry.

With a primary focus on exploring and producing minerals such as copper, iron ore, coal and nickel, BHP holds a significant position as the largest constituent of the S&P/ASX 200 by index weight.

As a frequent headline leader on the Australian Stock Exchange (ASX), it's no surprise that many Australians hold BHP’s shares. However, does size equate to investment excellence? In this article, we'll examine the potential investment opportunities presented by this mining giant.

Global copper leader:

BHP is a major player in the copper industry, boasting the world’s largest copper mineral resources and a strong commitment to renewable energy.

The company owns and operates the Escondida mine in Chile, which is the world’s biggest copper mine, with a 57.5% stake. In a bid to fortify its position in the industry, BHP has recently shifted its focus towards acquiring "tier one" copper operations—large mines with a long lifespan—across the globe.

Copper is the third most widely used metal after iron and aluminum, with a surge in demand expected due to the adoption of zero-emissions targets and the need for clean energy production and transmission. Additionally, the rise of artificial intelligence (AI) and the race for dominance in electric vehicles (EVs) are also driving demand for copper.

With limited new supplies and growing demand, copper prices have doubled in recent years. The price of copper futures on COMEX rose to over US$5.0 per pound in 2024 from US$2.1 per pound in 2020.

S&P Global estimates that annual demand for copper could rise to 40 million tons by 2030, up from 25 million tons in 2021. Given that it can take up to a decade to open a new copper mine, a shortfall is expected in the coming years. BHP's strong position in the copper market and its focus on acquiring large copper operations make it a potential investment opportunity for those looking to capitalise on the growing demand for copper.

Diversified product portfolio

As a commodity producer, BHP is a price taker and is highly dependent on low-cost mines with long lifespans and a low installed capital base to generate excess returns over the long term.

BHP has established itself as the lowest-cost major iron ore producer in Western Australia, and has achieved production records in copper mines located in South Australia and Chile.

In addition to its strong presence in the iron ore and copper markets, the company has a diversified product portfolio that includes coal, nickel and potash.

This diversification strategy helps to reduce exposure to any single commodity or market and enables the company to capitalise on opportunities across various markets and commodities.

For example, BHP holds the second-largest nickel sulphide resources globally and is actively seeking additional nickel resources thru exploration, acquisition and early-stage entry. The company is also developing one of the world's largest potash mines in Canada. This diversified product portfolio positions BHP to weather market volatility and capitalise on opportunities across various commodity markets.

Attractive shareholder returns

BHP has delivered impressive shareholder returns over the past decade, with an average annual return of 9.33%, outperforming the benchmark S&P/ASX 200 index, which returned around 8%.

However, investors should note that past performance is not necessarily indicative of future performance.

These returns are largely attributed to BHP’s high dividend payments, with a 12-month trailing dividend yield of around 5.7% (as of May 2024).

Over the past three years, BHP's annual dividend growth rate was 24.8%, which increased to 28.8% per year when extended to a five-year horizon.

While these dividend growth rates are impressive, investors should also examine the company's payout ratio to evaluate the sustainability of the dividends. The payout ratio indicates the percentage of earnings distributed as dividends. A lower payout ratio suggests that the company retains a significant portion of its earnings, which can be used for future growth and to cushion against unexpected downturns.

As of December 31, 2023, BHP's dividend payout ratio is 1.20, which may suggest that the company's dividend may not be sustainable.

Strong financial performance

Investment guru Warren Buffett advises investors to focus on return on equity (ROE), which represents how much net profit is generated by one unit of net assets.

Companies with higher ROE are more efficient at generating profits with their available resources and are often better investments.

According to data from moomoo, $BHP Group Ltd (BHP.AU)$ has delivered robust ROEs in recent years, surpassing 15% for five consecutive fiscal years.

In addition to ROE, other key financial metrics such as revenue, earnings per share (EPS) and free cash flow (FCF) provide detailed information about the growth and resilience of the company.

Revenue:

The company’s revenue fluctuated over the past decade, with increases in 2021 and 2022 followed by a decline in 2023.

EPS:

The company's earnings per share (EPS) have shown mixed performance, with varying growth rates over the years. However, the most notable growth occurred in 2019 and 2022, when EPS experienced substantial increases.

FCF:

The company’s FCF also had a mixed performance, with fluctuating growth rates. The indicator grew substantially in 2021 and 2022, similar to its revenue.

Overall, BHP's solid financial performance and robust ROEs suggest that the company is well-positioned to deliver attractive returns for investors.

Potential drawbacks

While some investors view $BHP Group Ltd (BHP.AU)$ as an excellent long-term investment due to its financial strength and consistent dividend payments for over four decades, others may be cautious of the company's potential drawbacks, which include:

Dependence on commodity prices:

BHP’s revenue and profits are heavily influenced by the prices of the commodities it extracts and sells, such as iron ore, copper and coal. Market conditions and commodity price volatility can significantly impact the company's financial performance.

Environmental concerns:

BHP’s mining and resource operations have the potential to cause environmental damage, including the risk of environmental incidents, such as spills or leaks, which can lead to costly clean-up operations and damage to the company's reputation. The company has implemented various initiatives to mitigate these risks, but they remain a concern.

Geopolitical risks:

BHP operates in multiple jurisdictions, exposing the company to geopolitical risks such as changes in government policies, currency fluctuations and political instability. Changes in laws and regulations, particularly in emerging markets, could also negatively impact the company's operations.