South32’s Results Eagerly Awaited

This story features SOUTH32 LIMITED, and other companies. For more info SHARE ANALYSIS: S32

-Coal and manganese stand out
-Costs seen reducing
-Leverage to cyclical upswing
-Disparity in forecasts quite large
 

By Eva Brocklehurst

South32 ((S32)) has a clean sweep of Buy ratings on FNArena's database, seven in all. The former assets of BHP Billiton ((BHP)), which were de-merged in May, have produced a solid June quarter in terms of output, but brokers await further detail on targets and, importantly, FY16 guidance.

Most projects were within 5.0% of Macquarie's forecasts and metallurgical (coking) coal, zinc and manganese alloy beat the broker's estimates while misses were flagged on nickel and lead. The broker incorporates modest positive changes to estimates.

Implications of the net revenue impact from the fourth quarter data are immaterial to Morgan Stanley. What the broker is most keen on are the goals and targets post the de-merger that will be, hopefully, revealed at the FY15 results briefing. Manganese ore production was the biggest surprise for Morgan Stanley, with production and sales down 14% and 20% respectively. The broker acknowledges it did not allow enough for planned maintenance and industrial action in South Africa.

The highlight of the June quarter for Citi was the 23% increase in coking coal production, because of a strong performance in the Illawarra. Nickel production was down 19% because of the strike at Cerro Matoso, but less than the broker expected, while alumina production was also below estimates because of maintenance at Worsley. The broker also notes South32's depreciation will not rise as much as expected as BHP has now detailed the charges it will take on the assets.

Citi forecasts strong earnings growth in FY17 after a largely flat FY16, as costs are reduced and commodity prices rally. With forecast free cash flow generation of US$1bn the broker considers the company has several options to increase returns to shareholders or opportunistically acquire growth assets.

First dividend payment is expected at the FY16 interim result. Macquarie also expects FY16 production is likely to be flat, aside from grade declines at Cerro Matoso (nickel) and Cannington (silver) and the impact of three longwall moves at Illawarra (coal).

The issues for FY16 are largely what concern Credit Suisse as well. The broker likes the fact net debt is seen reducing over the next two years despite indifferent commodity price forecasts. The FY15 results and inaugural outlook are eagerly awaited. 

JP Morgan found the report a mixed bag. Key aluminium and alumina assets underperformed while Illawarra coal surprised on the upside. Given the company was created so that its assets could operate more efficiently with a leaner structure the broker expects the full year results will provide the first forum for management to answer on those measures. Still, the stock stands out in terms of valuation support and leverage to a cyclical upswing in commodity prices.

Coal and manganese ore stood out in terms of the growth they provided in the June quarter, in UBS' view. The broker expects the impairments the former parent will recognise could reduce South32's depreciation expense by around US$60m but have a negligible impact on free cash flow, likely offset by higher effective tax rates.

The uncertainty over these charges, tax rates and changes accounting for manganese – which has changed to equity accounted from consolidated – is the probable reason why there is such a disparity in various broker forecasts, UBS maintains.

On FNArena's database the consensus target is $2.39, suggesting 37.5% upside to the last share price. Targets range from $2.20 to $2.80.

See also, South32 Arrives With Focus On Yield on May 20 2015

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