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BHP share price surges on oil and gas deal: would I buy?

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The share price of FTSE 100 mining giant BHP Group (LSE: BHP) has hit new highs on news that the company will pay its biggest ever dividend and sell its oil and gas business.

Despite the stock’s gains, BHP shares still offer a dividend yield of nearly 9%. As an income-hunting investor, should I consider buying the shares for my portfolio today?

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Ditching fossil fuels

BHP’s board has seen the writing on the wall and decided to dispose of its oil and gas business. This will reduce the company’s carbon emissions and avoid the risk that the firm’s petroleum reserves could become worthless stranded assets in the future.

The disposal will be structured as a merger with Aussie firm Woodside Petroleum. What this means is that BHP’s oil and gas portfolio will be combined with those of Woodside, which will take ownership of the BHP assets.

It’s a logical plan, in my view, as Woodside is already a partner in some of BHP’s Australian gas projects. BHP’s petroleum business has generated less than 10% of its profits in each of the last two years, so this deal won’t make a big difference to future earnings.

However, BHP shareholders hoping for a cash windfall may be disappointed. Instead of cash, they will receive Woodside shares. They’ll then have to choose whether to hold on to Woodside — which currently offers a 6% yield — or sell the stock.

Record dividend

The Woodside deal was revealed alongside BHP’s latest annual results, which cover the year to 30 June. These contain some fairly impressive numbers.

BHP’s revenue rose by 42% to $60,817m last year, while pre-tax profit climbed 82% to $24,601m. Shareholders will receive a record dividend of $3.01 per share for the full year, including a final dividend of $2 per share.

These results price BHP shares on 10 times underlying earnings, with a dividend yield of 8.9%.

If this level of profit is sustainable, then I want to buy the shares. But mining is heavily cyclical, and I’m concerned that we might be near the peak of another mining boom.

BHP share price: what I’ll do

BHP’s surging profits have been driven by strong demand for iron ore from China. Last year, 80% of the group’s operating profit came from iron ore. Most of the remainder came from copper.

I’m bullish on copper, due to growing demand from renewable energy and electric vehicles. But I’m not sure if current market conditions for iron ore are sustainable. I’m also aware that BHP is starting to increase its spending on new projects. Capital expenditure is expected to rise from $7.1bn to $9bn over the coming year.

One final warning for me is that BHP shares are now priced at more than three times their book value. For me, this is a sign that the market might be nearing a top. I think BHP probably has another year of strong earnings ahead.  After that, broker forecasts suggest profits may fall. For me, it feels a bit too late to start buying, so I won’t be adding BHP shares to my portfolio today.

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Roland Head has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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