South32 going north – Investors’ Chronicle

South32 has been in negotiations with South African state power company Eskom for 18 months over selling its South Africa Energy Coal (SAEC) division. The miner had activated a hardship clause in the agreement and so was renegotiating the supply to a power plant, which had to be done before the sale could go through.

And this is not just a minor division that will increase the company’s margin when it is gone (although it will do that too). SAEC accounts for 40 per cent of South32’s workforce and 35 per cent of its closure and rehabilitation provisions, while RBC analyst Tyler Broda said last year getting it off the books would be a “key catalyst” for this financial year. The deal is yet to complete, but the fact that the share price held steady when South32 announced it would be handing over cash rather than receiving it to get the deal completed shows how SAEC is seen by the market. 

A relatively new player compared with other major mining houses, South32 – which was spun out of BHP in 2015 – has a collection of operations that offers exposure to what could be labelled ‘the secondary mining boom’. Gold, iron ore and copper are still having a moment, but with that massive investor interest comes high share ratings and questions over how long the strength can continue. South32 produces aluminium and mines zinc, lead, silver, steel ingredient manganese as well as thermal coal plus coking coal and metallurgical coal, which are chiefly used in steel making. While coal is obviously excluded from the energy transition boom, the type used for steel is still trading strongly.

One current downside is that its dividend yield is well off that of the diversified giants, although a long-running share buyback programme does add to shareholders’ overall returns. Buybacks were paused for most of 2020 because of Covid-19, but management added $250m to the programme, which now totals $1.7bn. Its half-year dividend, covering the six months to 31 December, was 1.4¢ or $67m, while $112m was handed back through buybacks in the period. Another $259m will go back to investors by September this year. 

 

 

No, not those metals

Investors in the mining space are fickle. They can leap from one hot commodity to the next regardless of actual supply and demand concerns. We are deep in bull market territory, however, driven by near-term supply issues, seen in copper and iron ore, and anticipated long-term changes to demand brought on by the energy transition. South32’s contribution to this transition is nickel and aluminium. Chief executive Graham Kerr said on 1 April the company would stick to “development projects which have a bias to base metals that are essential in a low carbon future” from now on. 

For a major aluminium producer, this is a tricky line to walk. Aluminium, which accounts for over a third of South32’s revenue, is in high demand in the manufacturing sector but also hugely energy intensive. The metal has crept up to a three-year high over $2,200/t in recent weeks, after it had fallen under $1,500/t as Covid-19 hit. 

The miner has two smelters in southern Africa, meaning the sale of its thermal coal business there offers an interesting test of emissions accounting. It is possible those emissions will move from scope 3 to scope 2, given coal power is dominant in the country. In the first half, its Hillside aluminium-smelting operation accounted for 85 per cent of South32’s scope 2 emissions, or 11m tonnes CO2 equivalent. 

Like the majors, South32 wants to hit net zero carbon emissions within the next 30 years. Its metallurgical coal sales mean scope 3 emissions, which would be from steelmakers, will be extremely hard to shift. If the steel industry can cut its emissions, it would be by shifting to new technologies that don’t use coal anyway. 

A planning body in New South Wales might have done the company – if not its workers or the local steelmaker – a favour by blocking a planned expansion of the Dendrobium underground coal mine, given the intense suspicion about coal among investors. Without this expansion, the mine could close in a few years, rather than carry on until 2048. 

 

Looking ahead

Exchange rates and other non-cash impairments hit South32’s first-half after-tax profit, dropping it almost half compared with the first half of 2020 to $53m, but underlying earnings were up 4 per cent, to $136m, and the investor payouts are continuing.

 

The year ahead offers strong earnings because of strong prices for aluminium, nickel and metallurgical coal, while production will climb year on year for zinc, aluminium, manganese and metallurgical coal. 

Further out, South32 has an interesting suite of mines to build. These include a Mexican base-metals project with zinc, lead, silver and manganese, the Ambler Metals joint venture, which has base metals and gold. These won’t be operating next year or the year after, but South32 is putting $75m into the Mexican prospect this year and a pre-feasibility study is expected by the end of the year. 

South32 has also sold off an asset and made money this year. It sold three gold royalties, which are rights to a proportion of future sales, for $40m in cash and $15m in shares in Elemental Royalties (Can:ELE), making it a 19 per cent shareholder. 

 

What’s the difference

Why buy a second-tier miner when the biggest companies in the sector are doing so well? Building a portfolio is about spreading risk. South32 looks cheap valued on earnings and offers exposure to the broader industrial strength story, with a different suite of metals to the majors and less governance risk than Glencore (GLEN), which also has zinc and nickel. Rio Tinto (RIO) mines aluminium but relies on iron ore for its earnings. 

South32 without the South African coal assets is a better group and will have more cash to throw around once this deal is done, despite having to fork over $200m to Seriti. Buy.

South32 (S32)
ORD PRICE:	160p	MARKET VALUE:	£7.58bn
TOUCH:	158-160p	12-MONTH HIGH:	163p	LOW:	92p
FORWARD DIVIDEND YIELD:	3.2%	FORWARD PE RATIO:	15
NET ASSET VALUE:	144p	NET CASH:	$275m

Year to 30 Jun	Turnover ($bn)	Pre-tax profit ($bn)	Earnings per share (ȼ)	Dividend per share (ȼ)
2018	7.55	2.21	25.0	14.0
2019	7.27	0.80	7.7	9.6
2020	6.08	0.12	-1.3	3.2
2021*	6.16	0.60	8.0	4.0
2022*	6.40	1.04	15.0	7.0
% change	+4	+74	+88	+75
NMS:
Beta:	1.4
*Consensus via FactSet forecasts
£1=$1.37