The evolution of South32 continues under long-serving CEO Graham Kerr. Many investors identify the company as a spin-off from BHP in 2015, but the business is revising its portfolio towards the crucial elements required in electric vehicles and renewable power generation.
The acquisition (45%) of the Sierra Gorda copper mine for US$1.4 billion upfront (plus a contingent price-linked payment) brings immediate volume and future profit growth in a key commodity for decarbonisation. This business is a fully operational open-cut mine with a 20-year reserve life of 1 billion tonnes (100%) of copper, molybdenum, and gold. S32 is anticipating a medium term target of 200-210kt of copper equivalent production. There is also potential for exploration across the substantial land package.
S32 will double its green aluminium capacity using renewable power sources, from 273kt in FY22f to 510kt in FY23f. Increased ownership of Mozal Aluminium and restarting the Brazil Aluminium smelter will lift group aluminium production to approximately 1,230kt in FY23f.
S32 is conducting a pre-feasibility study (PFS) on the Hermosa (Chile) Taylor and Clark Zn-Pb-Ag deposits. It is expecting to spend ~US$1.7 billion to develop the asset with first production in FY27. The deposit could produce ~111ktpa of zinc and ~138ktpa of lead for 22 years.
The company’s capital management framework has supported a minimum 40% distribution of underlying profits as dividends. The excess capital has been variously allocated between reinvestment in the business (including acquisitions) and more shareholder returns (buybacks, special dividends). In the last five years, shareholder returns have amounted to 83% of underlying earnings. The company has approximately US$260 million remaining in its current share buyback program which will expire in September 2022.
The next few years appears to favour more investment in the business with capital expenditure lifting to around $2.7 billion over the next three years. Sustaining capex is around $600-700 million per annum so the extra amounts are being applied to growth projects.
Investment view
S32 admits to some cost pressure appearing throughout its businesses but has acted, where possible, to mitigate these such as hedging electricity costs in South Africa. Higher commodity prices look set to be sustained for a while longer which certainly helps free cashflow generation. The Board has been proactive in its focus on shareholder returns and the company carries an attractive dividend yield.
The transition of the portfolio towards providing the necessary elements for an inevitable global surge in electric vehicles and renewable power generation is driving investment in new assets.
Risks to investment view
Changes to commodity prices, operational efficiency (volumes and unit costs), foreign exchange and interest rates plus relevant regulation and legislation in each geography present the key risks to earnings.
Recommendation
We initiate our coverage of S32 with a Hold recommendation.
Unsurprisingly, S32’s earnings are most sensitive to changes in aluminium and alumina prices. A +/- 10% change in each, changes S32 EBIT by US$293 million and US$199 million respectively.
Metallurgical coal is next on the list at US$185 million with Zinc the least sensitive at US$20 million.
