South32 Targets Growth Through Transformation

Commodities | 10:06 AM

South32's transformation into a copper and zinc-focused miner is gathering pace, with analysts highlighting production growth, a stronger balance sheet and an increasingly attractive valuation.

• South32 finishes FY26 with a strong June quarter
• Analysts highlight transformation post assets sale
• Sierra Gorda and Hermosa underpin growth profile
• Strong balance sheet expected to fund future growth

By Mark Woodruff

Fast-growing base metals producer South32 ((S32)) performed strongly in the June quarter with cash flow and unit costs bettering market expectations.

Heading into FY26 results on August 27, Morgans expects the Cannington silver-lead-zinc mine in Queensland to be the key driver of cash generation, with zinc equivalent production rising 29% quarter-on-quarter and restored rail access lifting silver sales almost fourfold.

Following the announced sale of its aluminium value chain assets to Alcoa ((AAI)) for an implied enterprise value of up to US$5.6bn on July 1, management expects around 85% of pro forma earnings to be generated from base and precious metals, reducing reliance on aluminium and alumina.

Barrenjoey believes this transforms South32 into a copper and zinc-focused growth story, ready to deliver 7% annual copper-equivalent production growth over FY26-FY31, supported by a pro forma net cash position of around US$4.7bn.

Despite the stronger balance sheet and growth outlook, Barrenjoey observes the shares trade on 4.2x FY28 EV/EBITDA, below ASX peers on 4.4-5.4x, despite those peers offering only between 1%-9% growth in annual copper-equivalent production.

The company’s earnings (EBITDA) margin is expected to increase to around 55% following the aluminium sale, from around 35% previously, reflecting a portfolio with greater exposure to higher-margin upstream mining operations.

While South32 (market capitalisation around $18bn) has traded on an average EV/EBITDA multiple of around 4.8x over the past five years, RBC Capital believes the shares warrant a 6-8x multiple, in line with base metals peers such as Sandfire Resources ((SFR)), Canadian-listed Lundin Mining and Swedish mining and metals company Boliden.

South32: A short history

South32 takes its name from the 32nd parallel south, an imaginary line that circles the Earth about 32 degrees south of the Equator. Following its 2015 demerger from BHP Group ((BHP)), many of the company's original operations were located close to this latitude.

Historically, aluminium, alumina and metallurgical coal dominated earnings. More recently, South32 has shifted its strategy towards copper, zinc, silver and other base metals through acquisitions and project development.

The US-based Hermosa project in Arizona has become the centrepiece of this strategy. Taylor, one of two deposits at Hermosa, is expected to become one of the world's largest undeveloped zinc-lead-silver mines.

The sale to Alcoa included the Worsley Alumina joint venture, Hillside Aluminium in South Africa and Brazilian alumina and aluminium assets. Mozal Aluminium in Mozambique is not included in the Alcoa transaction.

Current operations include the Cannington mine in Queensland, Illawarra Metallurgical Coal in New South Wales, the 45%-owned Sierra Gorda copper joint venture in Chile and the Hermosa development in Arizona.

Hermosa is the only advanced mine development project in the US capable of producing two federally designated critical minerals (manganese and zinc), making it eligible for various US government support programs.

Construction has been approved for a fourth grinding line at Sierra Gorda, which is expected to lift processing capacity and copper production over coming years. Meanwhile, Hermosa recently secured a key US federal permitting decision, allowing development to progress toward construction.

Combined, Sierra Gorda and Hermosa underpin South32's long-term growth profile, with management forecasting production growth of around 55% from these projects.

Collectively referred to as South32's manganese business, the company also retains exposure to Australia Manganese and South Africa Manganese, both 60%-owned operations with Anglo American.

June quarter results

For the June quarter, South32 reported copper production -8% below Macquarie’s expectations, offset by better-than-projected outputs for silver, zinc, lead and manganese of 24%, 6%, 9% and 7%, respectively.

Citi nominated silver production as the standout at Cannington, coming in 23% above the consensus estimate.

Overall, production exceeded Citi's expectations for alumina, aluminium, silver and manganese, partly offset by weaker-than-expected copper production at Sierra Gorda (an -8% miss against consensus) and softer lead and zinc output at Cannington.

For Morgans, Sierra Gorda copper production of 16.0kt was the only notable disappointment, missing this broker’s forecast by -13% after weather disrupted mine access and forced lower-grade ore to be processed through the mill.

As a positive, FY26 copper equivalent production still exceeded guidance by 2%.

Output from Queensland’s Cannington silver-zinc mine benefited from higher grades and improved mine access following wet weather interruptions, Ord Minnett explains.

Manganese production exceeded consensus expectations at the Groote Eylandt Mining Company (GEMCO) operation in the Northern Territory and the majority-owned Hotazel Manganese Mines (HMM) joint venture in South Africa.

FY26 and FY27

Any impact on Morgan Stanley’s FY26 earnings forecasts will be negligible, as lower commodity prices offset higher production volumes, while higher costs at Australia Manganese are largely offset by lower costs at Cannington.

FY26 costs are expected to be around -10% above/worse than guidance at Sierra Gorda and Australia Manganese, and -5% worse at South Africa Manganese.

By contrast, Cannington costs are expected to be around 10% better/less than guidance, while Worsley costs should be broadly in line.

For FY27, production guidance was maintained across all operations except Australia Manganese, with revised guidance to be provided alongside the FY26 results as progress is made on water management, infrastructure investment and mine planning.

Morgan Stanley observes guidance points to lower production and higher costs at Australia Manganese in FY27.

The balance sheet

Ord Minnett highlights South32's robust balance sheet, underpinned by a pro forma net cash position of US$4.7bn.

With Mozal, one of Africa's largest aluminium smelters, having sold its remaining inventory and rail access to Cannington normalising during the quarter, working capital is expected to unwind by around -US$200m in the second half of FY26.

Citi expects cash generation to remain strong, supported by this working capital unwind and capital expenditure tracking below its forecasts.

Barrenjoey believes the stronger balance sheet is sufficient to fund the existing growth pipeline, including Sierra Gorda's fourth grinding line and Hermosa, while still supporting additional shareholder returns.

The company is also expected to pursue further organic growth opportunities, including the Ambler Metals joint venture and mine life extensions at Hermosa via the Peake and Clark deposits and at Sierra Gorda through Catabela Northeast.

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