1 March 2020
South32 (S32) FY18 result was solid in our view, with underlying EPS up +19% to US10.5cps, and revenue up +9% to US$7.6bn.
|Date of Report||ASX||Price||Price Target||Analyst Recommendation|
|Date of Report|
|Sector : Materials||52-Week Range: A$2.79 – 4.07|
|Industry: Base Metals||Market Cap: A$17,356m|
We rate S32 as a Buy for the following reasons:
- Attractive relative valuation to peers.
- The current share price trades below our valuation and price target.
- We estimate the Company will produce approximately US$3.5bn in free cash flow over the next three years, adequate to support growth and capital management.
- Significant cash on the balance provides flexibility = capital management.
- Bolt-on value accretive acquisitions.
- Potential corporate activity.
We see the following key risks to our investment thesis:
- Decline in key commodity prices.
- Significant shock to global growth.
- Cost blowouts/ Production disruptions.
- Company fails to deliver on adequate capital management initiatives.
Figure 1: S32 Revenue by segment
South32 (S32) FY18 result was solid in our view, with underlying EPS up +19% to US10.5cps, and revenue up +9% to US$7.6bn (ahead of consensus estimates), driven by stronger commodity prices and record production at Australia Manganese (up +10%) and Mozul Aluminium (up +20%).
Underlying EBITDA was up +4% to US$2.5bn, although EBITDA margins fell -160bps to 37.3% (from 38.9% in the pcp). Cost pressures are likely to presist in coal and aluminium.
However, higher commodities prices (current spot) do provide upside potential to earnings. Balance sheet remains in a solid position, net cash balance of US$2.0bn, however this will be utilised for the Arizona acquistion. A special dividend of US3.0cps was returned (with 81% franking) as part of S32’s capital management program, on top of the upcoming fully franked final dividend of US6.2cps (US$317m – representing 40% of underlying earnings in 2H18), leaving US$380m to be returned to shareholders by April 2019.
We upgrade our recommendation to Buy on valuation grounds, with the share price trading below our valuation of $3.90. S32 has a strong balance sheet, potential for additional capital management and growth options, whilst trading at a discount to peers (this should close over time). We estimate the Company will produce approximately US$3.5bn in free cash flow over the next three years on a cumulative basis, meaning capital management remains in play despite acquisition.
- Cost pressures somewhat relieved. Despite steepening cost curves during the first half and broader inflationary pressures (most notable in the aluminium supply chain), stronger production and improvements in energy and equipment productivity have enabled S32 to achieve FY18 Operating unit cost guidance and further mitigate such pressures. The stronger U.S. dollar and lower caustic soda prices are forecasted to provide additional relief.
- Acquisition of Arizona Mining. S32 has agreed to acquire 83% of Arizona Mining for all cash offer of US$1.3bn. Whilst we expect S32’s cash balance to reduce on the back of this acquisition, we expect cash balances to build up again over the coming years as the Company produces significant amount of free cash flow. We, therefore, expect capital management initiatives to remain priority and likely in the absence of growth options.
- Capital management program. S32’s net cash position remains healthy, increasing by US$401m to US$2.0bn after US$1.0bn was returned to shareholders via ordinary dividends (US$554m). Until now, S32 has completed US$620m of the approved US$1bn capital management program (having also paid a special US$154m dividend in April 2018 and share buyback of a further 98m shares throughout FY18 for a cash consideration of US$254m). This is reflective of management’s disciplined capital management program, with the Board paying out a fully franked final dividend of US6.2cps.
- Attractive relative valuation. Relative to its peers group average, S32 is trading at a reasonable discount on the EV/EBITDA measure. On consensus estimates, S32 is trading on an EV/EBITDA multiple of 4.8x 2-Yr and 4.7x 3-Yr. Relative to its peer group the stock also offers a solid yield on top of the capital management initiatives.
S32 FY18 RESULTS SUMMARY
Figure 2: Revenue by segment
Source: Company, BTIG, Bloomberg
Key components of the result: 1. Underlying EBITDA up +4% to US$2.5bn, although EBITDA margins fell -160bps to 37.3% (from 38.9% in the pcp). 2. Underlying earnings rose +16% to US$1.3bn (from US$1.1bn pcp), driven by higher commodities prices, which were only partially offset by a -7.0% decline in volumes and broader inflationary pressures (most notably in aluminium). 3. Free cash flow from operations at US$1.4bn, with a closing net cash balance of $2.0bn. 4. NTA per share was US$2.05 (up +7.3% from FY17). 5. A special dividend of US3.0cps was returned (with 81% franking) as part of S32’s capital management program, on top of the upcoming fully franked final dividend of US6.2cps (US$317m – representing 40% of underlying earnings in 2H18), leaving US$380m to be returned to shareholders by April 2019.
Figure 3: S32 Earnings Waterfall Source: Company, BTIG, Bloomberg
FY19 Outlook. Management expects a +5% increase in production volumes from: 1. Improved longwall and recovery from the extended outage at the Appin collery in 1H18 is expected to underpin 6.1Mt of production and consequent return to historical rates of >8Mt/annum from 2H20. 2. Zinc production expected to remain unchanged until FY20 as increases in payable zinc production offsets lower silver and lead ore grades. 3. Production guidance at South Africa Energy Coal has been lowered as a result of an extended outage on the dragline. 4. Payable nickel production guidance increased by 1.7kt to 40.5kt given expectations for higher throughput and utilisisation rates. 5. Capex is expected to increase by US$97m to US$465m in FY19 to facilitate the progressive ramp up in production to historic rates > 8Mt/annum.
S32 peer-group analysis…
Relative to its peers group average, S32 is trading at a reasonable discount on the EV/EBITDA measure.
Figure 4: S32 comps table
Source: BTIG, Company, Bloomberg
Figure 5: S32 Financial Summary
Source: BTIG, Company, Bloomberg
South32 (S32) is a globally diversified metals and mining company. S32’s strategy is to invest in high quality metals and mining operations where their distinctive capabilities and regional model enables them to extract sustainable performance. The regional model means their businesses are run by people from within the region. The company’s African operations are supported by a regional office in Johannesburg South Africa and Australian and South American operations by an office in Perth.