South32: Portfolio changes adding up

About the author:

Adrian Prendergast
Author name:
By Adrian Prendergast
Job title:
Senior Analyst
Date posted:
08 December 2021, 12:00 PM
Sectors Covered:
Mining, Energy

  • We upgrade our rating on South32 (ASX:S32) to Add, from Hold, after including the Sierra Gorda acquisition in our estimates as it nears completion.
  • A solid acquisition introducing copper, molybdenum and gold to the portfolio.
  • Immediately earnings accretive, +12% to FY23F EBITDA.
  • S32 continues to make smart moves at a portfolio level, while promoting its position as the most diversified miner on the ASX (easily).
  • A value and earnings accretive transaction that adds to S32’s investment appeal.

Event: Acquiring 45% interest in Sierra Gorda

S32 is in an advanced stage of acquiring a 45% interest in the 180,000tpa Sierra Gorda copper operation in the mining-heavy Antofagasta region of Chile.

Strategy wise S32 continues to hit the right notes, gradually working its way out from under the portfolio it inherited from parent BHP in 2015. S32 has increased its base metals exposures while reducing coal, and in the process improving the quality of its earnings, cash flow and ESG profile.

The US$1.55bn acquisition is not transformative, but combined with growth assets like Hermosa (zinc-lead-silver), S32 is upgrading its base metal business.


We estimate group EBITDA margin to increase from 39% to 43% while adding an extra ~US$300m to FCF which we now estimate at US$1.9bn in FY23F (first full year of ownership).

The acquisition also adds low-cost organic growth potential if the JV can execute on their intention to lift output from Sierra Gorda. The operation had a troubled performance early in its life before more recently starting to hit its stride.

While at a high level S32 is incrementally improving the position of its business. Improving its exposure to ‘future-facing’ commodities like copper, exiting ‘sunset’ commodities like thermal coal, and improving its country risk (adding Chile while removing South African thermal coal and manganese alloy).

Acquiring Sierra Gorda also improves S32’s long-term production profile, offsetting declines elsewhere in the business with long-life production (20+ years).

Forecast and valuation update

We have included Sierra Gorda into our forecasts, and made a number of adjustments to production forecasts across S32’s business as part of a review of assumptions (summary of changes further).

Net of these changes our valuation on S32 has been lifted to (login to view), with EPS increasing in FY22-24F by +10%/+25%/+21%.

Investment view

We upgrade our recommendation on S32 to Add, from Hold, seeing an attractive investment proposition of upside to our target, an attractive 7.6% dividend yield FY22F, and capacity to keep pursuing new growth.

S32 also boasts superior diversification compared to its fellow ASX mining peers (with BHP divestments in oil & gas and coal, RIO’s oversized iron ore exposure, and FMG’s single exposure to iron ore and ground-floor entry into renewables).

Price catalysts

Sierra Gorda deal completion.

Hermosa progress (Taylor Deposit PFS and Clark Deposit scoping study).

Half year earnings and dividend result.


Execution risk on Hermosa and Sierra Gorda.

COVID-19 related risks to demand drivers for key metal exposures.

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Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.

Solid top-line outcome: BAP’s 1Q22 revenue was flat on the pcp, an extremely resilient result given the extent of lockdowns in the period (~70% of stores impacted) and the strength of the pcp (cycling 27% growth). Composition comprised: Trade +2%; NZ -10%; Retail -12%; and Specialist Wholesale +7%. Overall, BAP stated that non-lockdown areas are outperforming expectations. ▪ 1Q22 trade & retail: Trade/Burson revenue was up +2% on the pcp (LFL sales - 1%; cycling 8% pcp); NZ/BNT revenue was down -10% (LFL sales -15%; cycling +4%); and Retail/Autobarn revenue was down -12% (LFL sales -16%; cycling +36%). Within the Retail segment, online sales were +80% on the pcp. Stores percentages impacted by lockdown were: Trade 70%; NZ 100%; and Retail 50%. ▪ Specialist segment results: Specialist wholesale revenue is up 7% on pcp, with Auto electrical/Truckline divisions ‘performing strongly’; and WANO underperforming. ▪ GM pressure expected to be temporary: BAP stated GM was stable across Wholesale and NZ (45% of FY21 revenue); and down ~50bps Trade and Retail (~55% of FY21 revenue), driven by promotional and online pricing in lockdown areas (we assume no margin pressure witnessed in non-lockdown areas). BAP expect margins to revert once lockdowns ease. ▪ The cost base has increased vs pcp, a function of duplicated DC costs (commencement of new VIC DC), and higher group and team member support (covid related) costs. BAP noted FY22 store rollouts and refurbs are on track.

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