South32 Chasing Catch-Up In Coming Quarters

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

South32 hasn’t delivered the start to the new financial year the market had hoped, missing production forecasts across multiple assets including coal.

-A disappointing first quarter has driven South32 to downgrade coal production guidance
-Company needs a big catch-up in the second half to meet FY23 targets
-Despite prospect of economic recessions in 2023, most analysts retain a positive view

By Danielle Austin 

Production-wise, South32 ((S32)) delivered a mixed bag in its first quarter of the new financial year.

Strong results from Sierra Gorda’s copper operations and Gemco’s manganese operations saw better-than-forecast copper and manganese production volumes. However, volumes of coal, alumina, zinc and nickel all failed to meet expectations. Despite the soft half, guidance was maintained across ten operating assets, with only coal production downgraded.

Coal presented difficulties during the period, driving South32 to downgrade its full year production guidance -5%; now a strong second half is needed to meet targets. Illawarra delivered 1% quarter-on-quarter coal production growth, but sales volumes declined -26% on product availability. Analysts highlighted a scheduled longwall move could result in lower output in the third quarter. 

Zinc and nickel, from the Cannington and Cerro Matoso projects respectively, are expected to be second half weighted as creep projects are completed. Cost guidance was maintained, with the company expecting weaker currencies in producer countries Australia, Brazil and South Africa to offset impacts of the US dollar. 

Robust second half could see the company meet guidance, according to analysts

All seven database brokers are largely in agreement that despite a soft quarter, South32’s longer-term outlook remains solid. Ord Minnett (Hold, target price $4.10) is the stand-out as this broker remains cautious on the outlook for commodities in general.

Six brokers are equivalent Buy rated, with only Ord Minnett equivalent Hold rated. An average target price of $4.76 results from a range from $4.10 to $5.50.

Ord Minnett highlighted South32 can no longer rely on cost relief from a lower Australian dollar, and raised concerns as to how the global economic growth outlook (facing a material slowdown)  will impact on commodity prices and thus on the company's outlook.

Ord Minnett's profit forecasts are more than -40% below consensus for the current year. The broker notes the stock offers relatively inexpensive exposure to base metals, and expects the share price will climb over the coming year, but not enough to support a more positive view. 

Outside of database brokers, Goldman Sachs (Neutral, target price $3.60) anticipates South32 will suffer an -80% earnings decline in the current year on lower base metal pricing and generate just a 2% free cash flow yield. This broker sees no upside to its twelve month target price, but does expect recovery in base metal pricing in FY24, which should drive a 17% free cash flow yield that year. 

Despite a slow start to FY23, Morgans (Add, target price $5.30) retains a positive bias. The strong production from the Sierra Gorda mine has appeased the broker’s concerns around performance from the mine in recent years. Morgans likes that South32 has demonstrated that extra tonnes can be unlocked from the mine through debottlenecking. 

Similarly, Macquarie (Outperform, target price $4.40) expects South32 will deliver improvement in the second half across multiple divisions, anticipating higher throughput from Cannington and improvements in Brazil aluminium and Illawarra coking coal production, as well as volumes from Cerro Matoso.

The soft quarter does drive a -17% downgrade to Macquarie’s earnings per share estimate for the current fiscal year, with only minimal changes for subsequent years.

Citi (Buy, target price $4.60) considered the quarter a solid start to the fresh year, while UBS (Buy, target price $5.50), Credit Suisse (Outperform, target price $4.10) and Morgan Stanley (Overweight, target price $5.30) acknowledged the softer quarter reflected planned maintenance, weather impacts and industrial action.

Morgan Stanley highlighted sales will need to play catch up throughout the remainder of the year to meet full year targets, which is considered achievable. 

Also outside of database brokers, Shaw and Partners (Buy, target price $6.00) considers the first quarter a solid platform from which South32 can reach its full year guidance for 13% year-on-year growth.

This broker finds the quarterly result to reflect operational and financial consistency from the company, and highlights a number of catalysts expected in the coming two quarters. Potential catalysts identified by Shaw include the upcoming AGM, scheduled for October 27th, as well as further progress on the Clarke and Taylor projects, and eastern leases at Gemco.

Shaw also highlights South32 is likely to be included when investors' focus centres on future facing commodities.

FNArena's consensus price target of $4.75 suggests 32% upside from yesterday's closing share price.

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