South32 Closer To Being Free Of SAEC

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As widely suspected, South32 has agreed on a last-minute revamping of the sale of South Africa Energy Coal, allowing greater focus on more prospective resources

-Earnings momentum improving
-Could release cash to top up the buyback
-More appealing to a wider range of investors
 

By Eva Brocklehurst

The time is approaching when South32 ((S32)) will be unshackled from South Africa Energy Coal but not without a final revamping of the sales agreement in order to improve the sustainability of that business under its new owner.

Free of these large thermal coal assets, South32 will be able to concentrate on its more prospective resources such as manganese, nickel and silver, all of which are experiencing robust prices.

Macquarie points out earnings momentum for South32 has started to improve and the stock is trading on free cash flow yields of 8-10% on its forecasts on spot prices. This is higher than consensus estimates suggest and the broker believes consensus will re-rate higher over the next 12 months.

Citi expects earnings (EBIT) will double to almost US$2bn in FY23 on its commodity price forecasts. The broker was not surprised the company agreed to sweeten the terms of the sale of SAEC, noting the business has not been profitable over the last three halves.

South32 has maintained a strong net cash position since listing and Ord Minnett believes part of the reason is a lack of profitability in SAEC through the cycle. Once this is sold, the broker expects the company will be more comfortable with a zero or small net debt position and this could release cash to top up the current US$250m buyback.

There appears to more certainty now around the transaction proceeding, Ord Minnett adds, which will improve the South32 credentials in terms of ESG (environment, social, governance) and allow new investors on the register. It will also reduce capital intensity and make for a leaner balance sheet.

More Attractive

Removing the SAEC business makes the stock a better prospect for investors as many large institutional investors were unable to take up the stock because of its thermal exposure. South32 still has exposure to thermal coal via Illawarra Coal but Ord Minnett suggests this is likely to be below some investor thresholds.

SAEC is a capital intensive business because of an ongoing need to extend mine life, which the broker points out accounted for around one quarter of overall capital expenditure during the past five years.

Morgan Stanley agrees many were anticipating a renegotiation as completion drew near. While the metrics of the sale are lower than expected, provisions for the asset were always likely to rise from ongoing reform in South Africa. Hence, the broker assesses the cost becomes manageable seen from a group perspective as South32 attempts to reduce its involvement in thermal coal.

Amendments

The amendments to the sales agreement with Seriti include removing the deferred payment mechanism and adjusting the up-front cash payment to a nominal consideration.

A US$50m facility with a subsidiary of Seriti will be provided by South32 to fund costs incurred for the restructure of certain loss-making mining areas, repayable over 10 years provided coal prices exceed certain thresholds. A bank guarantee by one of the South32 subsidiaries for US$120m will accompany this for a five-year working capital facility for Seriti.

A US$200m will fund rehabilitation involving for annual instalments of US$27.5m followed by six at US$15m. The final condition outstanding is the approval by electricity supplier Eskom of the transfer of the Duvha power station coal supply agreement.

On FNArena's database there are six Buy ratings and one Hold (Morgans) for South32 with a consensus target of $3.10 that suggests 9.5% upside to the last share price.

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