Brokers Urge Caution On South32 Outlook

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

-Stockbrokers awaiting update on costs, FY17 guidance from South32
-Depressed commodity prices weigh on forecasts
-Favourable FX conditions diminish
 

By Eva Brocklehurst

South32 ((S32)) has largely achieved its cost reduction targets emanating from restructuring and maintains it is on track to achieve FY17 unit cost guidance. Restructuring initiatives at five operations – Worsley, Illawarra coal, manganese in Australia and South Africa, and Cerro Matoso nickel – are now complete.

The company reported a 4% lift in copper equivalent production in the June quarter, with metallurgical coal, manganese and silver/lead/zinc offsetting a modest decline in alumina. Deutsche Bank estimates the net company's cash position has increased to US$96m at the end of June from US$18m at the end of March.

Several brokers note the fact the company chose not to update on costs or reiterate FY17 guidance at this point. Hence, the cost position at the August results will be scrutinised. Deutsche Bank suspects, based on the strong June quarter, guidance may be lifted for some assets. The broker now forecasts a lift of 2% in copper equivalent production in FY17 with a decline of 3% in FY18 and 7% in FY19, as grade decline accelerates at the base metal mines.

Citi observes the share price has withstood the expected pullback in alumina and manganese, thanks to a rally in nickel and silver prices, which it now expects will also correct, supporting its Neutral rating on the stock. The broker does point out the company has make tentative steps to procure growth by entering into an option deal over the Huckleberry project in Canada. The farm-in will earn up to 70% of the property which is prospective for copper, nickel and platinum group elements.

Diversity has improved the South32 offering, Ord Minnett maintains. The largest driver in FY17 earnings is now coal (34%), followed by aluminium and alumina (26%) and then Cannington silver (24%), with the balance in manganese and nickel. The broker likes the attractive valuation, balance sheet and high quality assets but believes the over supply in key commodity markets needs to be addressed and investor sentiment towards commodities needs to improve before value can be realised.

Manganese alloy production was affected by power shortages in Tasmania, which led to the suspension of two of four furnaces, but these should return to full capacity this month. There was also a temporary reduction in throughput at Cannington in the quarter.

Credit Suisse makes slight upward adjustments (2%) to earnings forecasts for FY16. A dividend pay-out of 40% in the second half is assumed, but this is a small number – US0.4c – given the low earnings currently.

Stronger than expected sales result in a 32% increase to earnings estimates for FY16 and UBS forecasts net cash of US$130m at year end, with a full year dividend of US1c. The broker likes the strong balance sheet, improving cash flow and earnings momentum and, on this basis, retains a Buy rating.

The main surprise for Macquarie was the return to full production in South African manganese in response to better prices. Illawarra production and sales were also higher than forecast, while South African energy coal was lower.

The broker also flags the lack of an update on the cash balance or FY17 outlook and maintains that, where internationally diversified miners have benefitted from rapidly depreciating commodity currencies, these favourable conditions have reversed and could squeeze margins in the December quarter.

Macquarie suspects the deliberate exclusion of any update could signal a miss on cost targets for 2016. The broker remains bearish on the outlook for most of the commodities that South32 produces, hence an Underperform rating, but acknowledges in its calculations that, at spot prices, forecasts and valuation rise significantly.

FNArena's database contains two Buy ratings, five Hold and one Sell for South32. The consensus target is $1.78, suggesting 3.0% downside to the last share price. Targets range from $1.40 (Macquarie) to $2.00 (Ord Minnett, Morgans – yet to update on the quarterly).
 

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