Manganese Lights The Outlook For South32

This story features SOUTH32 LIMITED. For more info SHARE ANALYSIS: S32

The main positive from the South 32 quarterly production numbers was the performance of manganese assets while thermal coal was a key point of weakness.

-Raw material prices still adversely affecting aluminium smelter costs
-Guidance reduced for both alumina and thermal coal production
-Illawarra Coal production expected to lift in the June quarter
 

By Eva Brocklehurst

The outlook for diversified miner, South32 ((S32)), is mixed. A recent fall in the alumina price has emerged as a headwind just as the company lowers alumina production guidance, and thermal coal was a key point of weakness in the March quarter.

The main positive in the quarterly report was the performance of the manganese assets. In one of its few upgrades to forecasts, Macquarie upgrades the production outlook for both GEMCO (Groote Eylandt) and Hotazel (South Africa) to match guidance for FY19. Manganese assets in South Africa also benefited from a slight reduction in cash costs.

Otherwise, Credit Suisse finds some comfort in the fact there were no changes to unit costs guidance and suggests there are plenty of catalysts for the stock over the next 3-6 months, including the potential for more capital management. UBS notes the company returned US$37m via an on-market buyback in the March quarter and still has around US$75m left to return as part of a US$1bn capital management program that should be completed by September.

While cost guidance is unchanged, Macquarie remains sceptical and believes a miss on cost targets is now likely for a number of assets, with Worsley alumina (Western Australia) and Cerro Matoso multi-metal (Colombia) production most at risk. The company has also highlighted that raw material prices are still adversely affecting aluminium smelter costs.

Silver and lead sales from Cannington (Queensland) were materially lower in the quarter, reflecting the impact of flooding and a lack of rail availability. The company remains confident the shipments can be made up in the June quarter.

Alumina

Guidance has been reduced for two of the company's key cash-generating assets. Alumina production has been reduced by -4-5% and thermal coal by -6%. The lower production and higher costs have translated to -14-22% reductions to Macquarie's earnings forecasts for the next four years. As upgrade momentum has vanished the broker downgrades to Neutral from Outperform.

However, the stock appears fairly valued to Ord Minnett, based on a 4% forecast dividend yield on a one-year forward enterprise value/operating earnings (EV/EBITDA) multiple of 5.3x. The broker suspects, given the recent history of production downgrades, that this may weigh on market sentiment towards the stock.

Outages from maintenance at Worsley caused a reduction in alumina production in the quarter, while power outages and a poor boiler performance at Alumar (Brazil) also meant production was lower than expected. Guidance for both assets in FY19 have been reduced by -4% and -5% respectively.

Both Hillside (South Africa) and Mozal (Mozambique) aluminium smelters continue to experience elevated alumina prices while power availability is a growing issue. There was significant damage to power lines in Mozambique from Cyclone Idai.

Coal

Production of metallurgical (coking) coal at Illawarra (NSW) improved, although production guidance is unchanged, which suggests to Macquarie that assumptions of a recovery post the longwall move are likely to be to optimistic. UBS is more positive, looking for Illawarra production to lift by around 30% in the June quarter.

Meanwhile, South African energy coal shipments and production were weak, attributed to community protests, delays and a slower ramping up of the dragline at Klipspruit. A formal sale of the asset is expected to be completed in the first half of 2020. The company continues to expect binding bids in the June quarter and once these have been received the asset will be classified as a discontinued operation.

FNArena's database shows four Buy ratings and three Hold for South32. The consensus target is $3.91, suggesting 12.6% upside to the last share price. The dividend yield on FY19 and FY20 forecasts is 4.8%.

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