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

S32 Details

Maintaining a Diverse Portfolio: South32 Limited (ASX: S32) is a globally diversified metal and mining company with operations in Australia, Southern Africa and South America. The company also has a prospective portfolio of greenfield exploration partnerships targeting base metals in Australia, the Americas and Europe. The company is mainly involved in the production of bauxite, energy coal, metallurgical coal, alumina, aluminum, manganese, nickel, silver, lead, and zinc. S32 has a leadership position in alumina and manganese. The company’s portfolio is diversified by commodity and customers, which strengthens its resilience to the disruption of any one commodity, geography, or operation.

The company plans to optimize the performance of its existing operations and unlock its potential by converting high-value resources into a reserve. S32 continues to look for high returning options with a bias to base metals and the potential to deliver meaningful growth in shareholder value over the medium-term. In the last five years, the company has witnessed significant improvement in its bottom line, rising from a net loss of US$1,615 million in 2016 to a net loss of US$65 million in FY20. Over the years, the company has also improved its financial position, rising from a net debt position in 2015 to a net cash position in 2020, as demonstrated in the below graph. 

Net Cash Position (Source: Company Reports)

Despite the extraordinary circumstances and volatility caused by the COVID-19 pandemic, the company was able to deliver decent operating performance in FY20, demonstrating the strength of its diverse portfolio. In response to COVID-19, the company implemented several measures focused on keeping its people safe and well, maintaining reliable operations and supporting its communities.

Looking ahead, the company intends to take further actions as it continues to navigate a period of potentially extended market volatility and lower commodity prices. In FY21, S32 expects to increase production at the majority of its operations. Further, the company intends to achieve lower operating unit costs across its operations through cost efficiencies and higher volumes. In addition, by exiting low returning businesses and further simplifying its functional structures and footprint, the company expects to deliver another US$50 million in annualized savings from FY22.

FY20 Results Highlights: For the year ended 30 June 2020 or FY20, the company reported decent operating results despite the extraordinary circumstances and volatility caused by the COVID-19 pandemic. Over the year, the company achieved record production at three of its operations, namely, Australia Manganese ore, Hillside Aluminium and Brazil Alumina. Further, the company was able to record lower operating unit costs at the majority of its operations, which delivered US$50 million in annual savings.

One of the major highlights of FY20 was the signing of a binding conditional agreement for the sale of South Africa Energy Coal with Seriti Resources Holdings Proprietary. The sale is expected to be complete in the first half of FY21. During the year, the company formed the Ambler Metals Joint Venture in Alaska with Trilogy Metal, adding another exciting base metals project in its growth pipeline.

For the full year, the company generated revenue of US$6.07 billion, down by 16% on the previous year, impacted by the 20% decline in average realised prices.  For FY20, the company recorded a statutory profit after tax US$65 million and Underlying EBITDA of US$1.2 billion. During the year, the company generated free cash flow from operations of US$270M and received US$313 million in net distributions from its manganese EAI. The company recently declared a fully franked final dividend of US 1 cent per share, payable on 8 October 2020. At the end of FY20, the company had net cash of US$298 million.

FY20 Results Snapshot (Source: Company Reports)

Top 10 Shareholders: The top 10 shareholders have been highlighted in the table, which together form around 29.140%. Vanguard Investments Australia Ltd. and Schroder Investment Management Ltd. (SIM) hold the maximum interest in the company at 6.11% and 5.89%, respectively.

Top 10 Shareholders (Source: Refinitiv, Thomson Reuters)

Key Metrics: For FY20, the company’s EBITDA margin and operating margin stood at 16.1% and 4.3%, respectively. The company’s current ratio stood at 2.10x, higher than the industry median of 1.76x, demonstrating that the company is well placed to pay its short-term obligations. The company’s debt to equity ratio stood at 0.11x, lower than the industry median of 0.21x.

Key Metrics (Source: Refinitiv, Thomson Reuters)

Managing Financial Position Amid Covid-19: The company continues to manage its financial position to ensure that it has the right balance of flexibility, efficiency and prudence. In response to the volatility caused by the COVID-19 pandemic, the reduced its sustaining capital expenditure and suspended its on-market share buy-back program. The buy-back program has been extended by 12 months to September 2021, proving flexibility to the company to re-commence the program as COVID-19 related operational risks subside and its financial performance improves.

Mineral Resource Estimate Declaration: On 12 May 2020, the company reported a Mineral Resource estimate for the Clark Deposit which forms part of its 100% owned Hermosa project located in Arizona, USA. This deposit provides the company with an additional option to realise long-term value from within the broader land package.

Change of Directors’ Interest: Recently, one of the company’s Director, Graham Kerr, acquired 325,725 ordinary shares of the company by vesting 325,725 deferred rights held as short term incentive awards under the South32 Equity Incentive Plan. He now holds 3,618,010 ordinary shares in the company.

Key Risks: The company’s future performance is dependent on the impact of existing or additional COVID-19 restrictions or measures. Further, the company is also exposed to the risk of disruption of any one commodity, geography, or operation. The company’s operations and transport networks can be disrupted by events such as fire, explosion, flooding, loss of power supply, etc. The company is also exposed to the risks related to the actions by governments, political events, or tax authorities as changes in legislation, regulation, and policy can impact the company’s strategic goals and the way it works. The company uses a strong system of risk management in design, construction and operation phases, to analyse risks and design plans that prevent or limit business impacts.

What to Expect: In FY21, the company expects to increase production at the majority of its operations, subject to further potential impacts from COVID-19. At Worsley Alumina, the company expects FY21 alumina production to be around 3,965kt and at Hillside Aluminium, the company expects FY21 aluminium production to be around 718kt.

Further, the company intends to pursue cost efficiencies in its business to offset the impact of a stronger Australian dollar and the potential for an extended period of volatility and lower commodity prices. In addition, by exiting low returning businesses and further simplifying its functional structures and footprint, the company expects to deliver another US$50 million in annualised savings from FY22.

The company is progressing its development options through its study phase towards investment decisions. In FY21, the company intends to spend US$18 million on greenfield exploration with drilling programs scheduled at 12 projects. The company’s divestment of South Africa Energy Coal operation is on track to complete in H1FY21, subject to the satisfaction of a number of material conditions.

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 a YTD basis, the stock of S32 has corrected by 21.26% and in the last three months, it has provided a return of 7.69%. The stock is currently trading slightly below the average 52-week price levels. On the technical analysis front, the stock has a support level of ~A$2.03 and a resistance level of ~A$2.665. We have valued the stock using the 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 BlueScope Steel Ltd (ASX: BSL), Mineral Resources Ltd (ASX: MIN), Nickel Mines Ltd (ASX: NIC), etc. Considering the company’s decent FY20 operating performance, its FY21 production guidance, decent financial position, and its exit from low returning businesses, we give a “Buy” recommendation on the stock at the current market price of $2.170, up by 3.33% on 2 September 2020.

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

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