South32 Limited

Company Overview: South32 Limited (ASX: S32) is a globally diversified mining and metals company with operations in Australia, Southern Africa and South America. The company is mainly involved in the production of bauxite, energy coal, metallurgical coal, alumina, aluminum, manganese, nickel, silver, lead, and zinc. S32 is focused on securing high potential development options for the future while maintaining a leadership position in alumina and manganese. The company is listed on three continents and has operations across five countries. S32 owns high-grade zinc, lead and silver development option in North America and has partnered with several junior explorers with a bias to base metals.

S32 Details

Maintaining a Diversified Portfolio: South32 Limited (ASX: S32) is a globally diversified mining and metals company involved in the production of bauxite, energy coal, metallurgical coal, alumina, aluminum, manganese, nickel, silver, lead, and zinc. Its diversified portfolio strengthens its resilience to the disruption of any one commodity, geography, or operation. S32’s strategy is focussed on optimising the performance of its existing operations; identifying new opportunities to compete for capital; and unlocking the potential of current operations by converting high-value resources into the reserves. During 2015-2019, the company’s underlying EBIT and underlying earnings have increased at a CAGR of 9.5% and 14.61%, respectively.

Five Years Performance Summary (Source: Company Reports)

In response to Covid-19, the company has implemented several measures that are focussed on keeping its people safe and well, maintaining reliable operations and supporting its communities. Despite the health crisis in recent months, the company has observed good demand for its products, with sales exceeding production at the majority of its operations. The company continues to manage its financial position to ensure that it retains the right balance of flexibility, efficiency, and prudence.

Looking forward, the company remains focussed on reducing controllable costs, managing counterparty and supply chain risk and optimising working capital to ensure the business remains resilient during a potentially extended period of volatility and lower commodity prices. S32’s robust balance sheet and efficient capital management framework are designed to reward shareholders as its financial performance improves.

FY19 Highlights: Financial year 2019 or FY19 was an important year for the company as it was able to achieve important milestones over the period. During the year, the company completed the acquisition of Arizona Mining, acquired a 50% interest in the Eagle Downs Metallurgical Coal project, and progressed the divestment of South Africa Energy Coal.

In FY19, the company saw a solid operating performance and delivered underlying EBITDA of US$2.2 billion and a free cash flow of US$1 billion. The company witnessed record production at Hillside Aluminium, a 57% increase in volumes at Illawarra Metallurgical Coal and strong manganese ore production of 5.5 million tonnes, underpinning a 3% increase in the total production volumes. 

The company’s underlying earnings stood at US992 million in FY19. For the full year, the company paid a total dividend of US 7.9 cents per share to its shareholders.

H1FY20 Result Highlights: For the six months ended 31 December 2019 or H1FY20, the company reported revenue of US$3,216 million and underlying earnings of US$131 million. During the period, the volatile macro-economic conditions impacted the prices of the company’s key commodities. For the half-year period, the company declared a fully franked interim dividend of US$54 million.

During the period, the company delivered record production at Brazil Alumina and maintained higher output rates at Worsley Alumina. In response to lower manganese prices at South Africa Manganese, the company reduced the use of higher-cost trucking. S32 generated free cash flow from operations of US$124 million despite a 21% reduction in the average realised prices for its commodities. The company ended the half-year period with a net cash balance of US$277 million.

H1FY20 Results (Source: Company Reports)

Top 10 Shareholders: The top 10 shareholders have been highlighted in the table, which together forms around 29.14%. Vanguard Investments Australia Ltd. and Schroder Investment Management Ltd. hold the maximum interest in the company at 6.11% and 5.89%, respectively.

Top 10 Shareholders (Source: Refinitiv, Thomson Reuters)

Key Metrics: For H1FY20, the company’s EBITDA margin stood at 18%, higher than the margin of 7.5% reported in the previous half. The company has a current ratio of 2.03x, higher than the industry median of 1.85x, demonstrating that the company is well equipped to pay its short-term debts. The company has a debt/equity ratio of 0.11x, lower than the industry median of 0.16x.

Key Metrics (Source: Refinitiv, Thomson Reuters)

Strategic Exploration Alliance with AusQuest Limited:  On 10 March 2020, the company announced that AusQuest Limited (ASX: AQD) and S32 have agreed to extend the Strategic Alliance Agreement (SAA) that has been operational from 17^th February 2017, for a further two years (up to 31^st  December 2021) in order to continue developing a pipeline of high-potential exploration opportunities in Australia and internationally. Under the SAA, S32 will provide the necessary funds to complete the work programs on the Projects. Once a project is accepted by S32 as a Drill-Ready Opportunity, the company can elect to earn a 70% interest in the project.

Managing Covid-19 Impact: In response to Covid-19, the company has implemented several measures that are focussed on keeping its people safe and well, maintaining reliable operations and supporting its communities. In order to maintain the financial strength of its business during the current period, the company has lowered its FY20 sustaining capital expenditure guidance and has suspended the remaining US$121 million of its current on-market share buy-back program. The company has also initiated a review of activity across the Group aimed at delivering a meaningful reduction in controllable costs.

Key Risks: The company is exposed to the risks and threats of COVID-19 as it could impact its operations and the overall production performance. The company has activated emergency management teams to identify, prevent and respond to Covid-19 related risks as they arise. The company’s operations and transport networks can also be disrupted by events such as fire, explosion, flooding, loss of power supply, etc. S32 is also exposed to the risks related to the uncertainty surrounding direct and indirect taxes and royalties in the countries where it operates, as well as around broader policy decisions and regulatory changes.

FY20 Results Update: In FY20, the company achieved record production at Brazil Alumina, Hillside Aluminium and Australia Manganese ore. During the year, the production at Worsley Alumina increased by 2%. The company exceeded FY20 guidance at Cannington by 8% due to higher mill throughput, enabled by a drawdown in run of mine stocks and underground mine performance.

Despite the health crisis during the June quarter, the company witnessed good demand for its products, with sales exceeding production at the majority of its operations. During the June quarter, the company continued to reshape and improve its portfolio, progressing approvals for the sale of its shareholding in South Africa Energy Coal, placing the Metalloys manganese alloy smelter on temporary care and maintenance and advancing studies for its development options.

Production Summary (Source: Company Reports)

What to expect: With uncertainty remaining in global markets, S32 continues to manage its financial position to ensure that it retains the right balance of flexibility, efficiency and prudence. The company’s robust balance sheet and simple capital management framework are designed to reward shareholders as its financial performance improves.

It is scheduled to release its FY20 results on 20 August 2020. As per the recent update, the company will report solid operating results, highlighted by annual production records at Brazil Alumina, Hillside Aluminium and Australia Manganese ore.

The company is positioning itself for the next phase of growth in demand by creating a pipeline of opportunities to compete for capital, with a bias to base metals. Looking forward, the company will continue to focus on improving return on invested capital and prioritising a robust balance sheet to ensure that it remains in control through economic cycles. The company is also focussed on reducing controllable costs, managing counterparty and supply chain risk and optimising working capital to ensure the business remains resilient during a potentially extended period of volatility and lower commodity price.

Key Valuation Metrics (Source: Refinitiv, Thomson Reuters)

Valuation Methodology: EV/EBITDA Multiple Based Relative Valuation (Illustrative) 

EV/EBITDA Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)

 Note: All the forecasted figures are taken from Thomson Reuters, NTM: Next Twelve Months

Stock Recommendation: On YTD basis, the stock of S32 has provided a negative return of 17.51% on ASX. However, in the last three months, the stock has increased by 18.6%. The stock is currently trading below the average of its 52-week trading range, offering a decent opportunity for accumulation. We have valued the stock using an EV/EBITDA multiple based illustrative relative valuation method and have arrived at a target price of low double-digit upside (in % terms). For the purpose, we have taken peers like OZ Minerals Ltd (ASX: OZL), IGO Ltd (ASX: IGO) and, Mineral Resources Ltd (ASX: MIN). Considering the company’s decent balance sheet, excellent FY20 production results, capital management framework and current trading levels, we give a “Buy” recommendation on the stock at the current market price of $2.140, down 2.727% on 29 July 2020.

S32 Daily Technical Chart (Source: Refinitiv, Thomson Reuters)

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