South32’s Update Fuels Analysts’ Optimism

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Diversified miner South32 exceeded consensus production forecasts in the December quarter. Costs proved higher and prices lower than forecast.

-South32’s production exceeded consensus overall
-Costs higher and realised prices lower
-Australia Manganese set to recommence production
-Buybacks likely to be maintained

By Greg Peel

Diversified metals miner South32 ((S32)) reported strong December quarter production, with aluminium, alumina, copper and manganese production all above consensus forecasts. FY25 guidance has been maintained for all assets except for Mozal aluminium in Mozambique, given civil unrest in the country.

Realised pricing for the first half was on balance below forecasts due to pricing lags and timing, and unit costs are expected to be above FY25 guidance for the first half for most assets due to elevated consumable costs and/or inventory unwind. The timing of sales resulted in an increase in receivables, contributing to a working capital build of some US$120m in the quarter.

Production

December quarter aluminium production was up 3% on the prior quarter as Hillside (South Africa) continued to test its maximum technical capacity. Alumina was up 14% as Worsley Alumina (WA) completed planned maintenance and Brazil Alumina benefitted from improved plant availability.

Copper production was up 9% as Sierra Gorda (Chile) benefitted from improved ore quality in the current phase of the mine plan. While Cannington (Qld) zinc production was down -11%, lead and silver were up 57% and 86% to see zinc equivalent production up 56% thanks to higher lead and silver grades.

Manganese production was up 88% as Australia Manganese (Groote Eylandt) resumed production from the primary concentrator and progressed construction of infrastructure as per the recovery plan. The mine was flooded in March care of Tropical Cyclone Megan.

Construction of the Taylor zinc-lead-silver mine (Arizona) progressed as planned in the quarter, as South32 commissioned the hoisting system for the ventilation shaft and commenced shaft sinking.

Morgans was encouraged to see South32 flex alumina volumes, testing the upper operational limits of Worsley, against a backdrop of buoyant prices. Ongoing spot price strength provides a significant earnings tailwind heading into the second half. At Morgans’ current forecast alumina price of US$530/t for 2025, the broker expects South32’s alumina operations to account for a combined 52% of group earnings.

With spot prices materially higher than Morgans’ forecasts, upside risk to these assumptions remains.

Goldman Sachs highlights the strong performance from Sierra Gorda copper in Chile (up 9%), which delivered better than what was thought post the recent site visit to Sierra Gorda in November last year.

Despite civil unrest issues in Mozambique, and management’s withdrawal of guidance as a result, Mozal aluminium did not show any significant impact, Goldman notes, with production up by 2% for the quarter and 7% for the half.

Overall, production for the quarter was stronger across the board other than zinc production, down -11% due to grade variances at Cannington.

Costs

Unit costs for most assets in the first half are expected to be above FY25 guidance due to elevated consumable costs and/or inventory unwind. That said, although aluminium costs are expected to increase some 10% half-on-half, this is below Goldman Sachs’ prior forecast of a 15-20% increase.

The broker notes that some first half increases will likely be offset in the second half by weaker forex and a reversal of one-off inventory movements, but in Goldman’s view there could be some increases to 2025 unit cost guidance with the first half results in February.

Operating unit costs in the first half are expected to reflect the impact of higher raw material input costs in the aluminium value chain, Citi notes, but management expects operating unit costs in the second half to benefit from weaker producer currencies.

Finances

Post completion of its Illawarra (NSW) met coal sale for US$964m in cash proceeds, and ongoing operating cash flow generation, Morgans sees South32 as well positioned to support its dividend and further buybacks while advancing development of Hermosa zinc-lead-silver-manganese (Arizona).

The timing of sales resulted in an increase in receivables, contributing to the working capital build of US$120m in the quarter. UBS expects around -$100m in negative cash flow in the first half, to end the second half roughly net cash. South32 could increase its buyback amount with the first half results, but this is not UBS’ base case.

Insurance claims at Groote Eylandt of US$150m were granted in quarter, taking the first half total to US$250m. This carries the asset back to nameplate, Macquarie notes, with production restarting this quarter. Shipping resumption is expected in the December quarter.

Continued portfolio optimisation was highlighted by management, with the Cerro Matoso ferronickel (Colombia) strategic review to be delivered at the first half result. With cost/ production beats, the time for an asset disposal may be right, Macquarie suggests.

Broker Views

South32’s December quarter result was pleasing to Macquarie (Outperform) on the production and cost front. The broker awaits the first half result to assess cash flow impacts. Key catalysts are intact and pricing remains resilient.

Morgan Stanley (Overweight) highlights strong production across all assets, outperforming this broker’s forecasts significantly, with working capital likely released this half. Although higher costs were flagged across assets, Morgan Stanley still sees underlying operational performance setting the tone for stock performance.

The quarter was strong operationally across most assets but working capital and cost management remain a challenge, UBS (Buy) warns. Aluminium and copper performed better than expected and Cannington improved, delivering strong silver & lead output. Cash conversion remains in focus.

Morgans (Add) sees South32 as offering an attractive basket of mostly base metal exposures, sensitive to an eventual recovery in China/global growth. It also offers diversified exposure to alumina and aluminium, both currently enjoying a healthy up-cycle that could extend beyond consensus estimates, with alumina in particular supported by positive supply fundamentals.

The strong first-half run rate shows most of South32’s divisions are tracking ahead of full-year guidance, Ord Minnett (Buy) notes, and this has compensated for increased unit costs and weaker-than-forecast realised prices for some commodities in the quarter.

Post the quarterly report, Ord Minnett increases earnings forecasts, noting the still recovering Groote Eylandt manganese business is excluded from the broker’s underlying estimates.

Citi has raised earnings forecasts as it moderates bearish cost assumptions for Hillside and lifts Cannington price realisations, but nonetheless remains Neutral rated.

That leaves five Buy or equivalent ratings and one Hold among brokers monitored daily by FNArena covering South32. The consensus target price is $4.13, suggesting some 14% upside.

It is encouraging to see the improvement in operating performance, Goldman Sachs suggests, which sets up the company for a strong second half, especially with the restart of production from Groote Eylandt in the June quarter.

Goldman Sachs has a Buy rating and $4.00 target.

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