Divestment Of SAEC Critical For South32

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South32 has reinstated its buyback program, having built up cash reserves after a solid performance in the September quarter, while kicking off 2021 unencumbered by South Africa Energy Coal is considered critical to the outlook.

-Buyback could be extended
-FY21 production guidance maintained
-Dependent on recovery in key commodities
 

By Eva Brocklehurst

Metals and coal producer, South32 ((S32)), sustained a strong performance in the September quarter but the main news in its report was the reinstatement of the buyback as a result of the build up in net cash to US$368m.

The buyback could be extended in February, Credit Suisse suggests, anticipating the company could complete the remaining US$121m of the current program by December. UBS also anticipates the buyback will be completed at the end of the year and a top-up possible at the interim results in February.

The Hermosa (Arizona) pre-feasibility study has now slipped to the June half and Credit Suisse assesses timing of first production will also move out, albeit with a greater understanding of both the Taylor and Clark deposits and the prospect of greater scale as these are developed in parallel.

Morgans is reluctant to make assumptions about Hermosa, ahead of the  pre-feasibility study, given the few details available, but believes an up-scaled project will be worth waiting for.

A decision on the Eagle Downs (Queensland) metallurgical coal project is on track for the December quarter, but UBS does not expect the company will progress the opportunity, given the attractiveness of its existing resource base. Shaw and Partners also suspects South32 will choose not to proceed, and concludes this would be the most “favourable” outcome.

Plans are afoot at Illawarra Coal to extend the Dendrobium coking coal mine, with a final decision in the second half of FY21. Shaw considers this a positive development as it will extend returns from existing invested capital, although the projected returns are not stellar.

SAEC

FY21 production guidance is maintained, with the exception of South Africa Energy Coal (SAEC) where the company is now expecting the lower end of 10.5-12.5mt production in the first half. South32 expects a resolution on the future of SAEC by the end of the year.

UBS suspects the company is attempting to push regulators to a final decision on outstanding conditions and will, if this is not forthcoming, consider closure. Morgans, however, expects the competition tribunal will approve the deal, although acknowledges a positive outcome from public utility Eskom is harder to ascertain.

Divestment of SAEC remains a critical factor behind the broker's investment thesis, as a successful offloading of what has been a difficult asset will boost earnings quality and shrink the overall workforce meaningfully. There is potential for a re-negotiation of the sale to Seriti Resources before closure, a common occurrence in South Africa, Macquarie points out.

Goldman Sachs calculates the sale should deliver a $0.11 per share uplift in value. The broker remains positive about metallurgical coal, manganese and alumina prices in 2021, noting these commodities represent over 50% of the company's operating earnings (EBITDA). The cost reduction program could also result in further upside in FY21.

The September quarter was favourable across most of the company's commodities, manganese was up 19% with the South African unit at full production. The Worsley (Western Australia) alumina refinery is also nearing nameplate, expected in FY21.

Macquarie notes guidance for Hillside (aluminium, South Africa), where discussions around the new power agreement with Eskom are ongoing, and Mozal (aluminium, Mozambique) does not assume any impact from load-shedding.

In manganese, the company intends to divest TEMCO (Tasmania), with approval subject to the Foreign Investment Review Board. Metalloys (South Africa) remains on care and maintenance.

Over the next 12 months Morgans expects South32 will close its price discount as manganese, nickel and aluminium continue to recover. In contrast, Macquarie believes there is downside risk to earnings at spot prices, calculating earnings decreasing -17% in FY21 and -7% in FY22.

Of the seven stockbrokers not monitored daily on the FNArena database Shaw and Partners has a Buy rating with a $3.00 target while Goldman Sachs retains a Buy rating and $2.90 target.

FNArena's database has six Buy ratings and one Sell (Macquarie). The consensus target is $2.66, signalling 22.4% upside to the last share price. Targets range from $3.00 (Credit Suisse, Ord Minnett) to $1.90 (Macquarie).

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