South32: Finds value-accretive path into copper

About the author:

Adrian Prendergast
Author name:
By Adrian Prendergast
Job title:
Senior Analyst
Date posted:
18 October 2021, 11:00 AM
Sectors Covered:
Mining, Energy

  • South32 (ASX:S32) to acquire a 45% stake in the Sierra Gorda copper mine in Chile, adding copper and molybdenum into its already highly diversified business.
  • We are impressed with the strategy here, acquiring a non-operated interest in an asset that has had a troubled past (but better performance recently), getting S32 a cheap entry into one of the industry’s most sought after metals.
  • US$1.6bn upfront cash payment, and US$500m in price/production linked payments (which won’t be triggered in our base case).
  • Net debt of ~US$1.6bn post Sierra/Mozal acquisitions and dividend (0.6x EBITDA).
  • We have not yet included the acquisition as some conditions precedent and pre-emptive option remain active. We maintain our Hold recommendation.

Event

South32 (ASX:S32) has announced the agreed acquisition of a 45% non-operated interest in the Sierra Gorda copper mine in Chile from Sumitomo.

Upfront cash consideration of US$1.6bn, plus a further US$500m in contingent payments between 2022-25 (linked to copper price and production triggers).

We have not yet included the Sierra Gorda transaction in our base case given the 30-day pre-emptive period which KGHM could trigger, and typical approvals.

Analysis

If completed, we would view the transaction as value (+A$0.38ps) and earnings accretive (+17% EBITDA) based on our modelling.

Sierra Gorda has a poor reputation, as a low-grade mine with a complicated mill. The operation experienced significant commissioning issues in 2014-15 with impacted production and heavy costs.

These days the asset is performing better, in FY21 producing (100%) 180kt copper, 5kt molybdenum, 54oz gold and 1.6moz silver, at an operating cost of US$1.29/lb (AISC ~US$2.00/lb). Medium-term unit cost guidance for an increase to US$1.30-$1.50/lb is partly driven by the mine currently operating above reserve grade at 0.48% Cu (reserve 0.40%).

Further upside to these numbers is possible if: 1) JV can de-bottleneck the plant, 2) Catabela is developed (1.45mt @ 0.4% Cu, 0.06gpt Au, 0.02% Mo), 3) resource growth from regional exploration, and 4) JV can cut down the heavy sustaining capex profile.

We view Sierra as a smart entry into copper. A robustly popular metal, S32 has been able to strike a deal to add meaningful copper production by going for an asset where it would share joint operatorship. Majors focus on acquiring interests that come with operatorship, while the dynamic also helps to get the price tag lower.

S32’s capable balance sheet can digest the acquisition. After the Sierra Gorda acquisition, Mozal acquisition, and October dividend payment, S32’s balance sheet is expected to move from US$660m net cash to US$1.5bn net debt. This is a very manageable 0.55x ND/EBITDA, with S32 not expecting its credit rating to change.

Forecast and valuation update

We have not included Sierra Gorda in our base case S32 forecasts.

Updated coal and zinc price forecasts have been applied to our estimates (summary further in report).

Our target price has increased to (login to view).

Investment view

We have a strong positive view on the acquisition. While it may not be a tier 1 asset, it is producing healthy free cash flow with room for growth, in one of our favourite commodities.

While positive, the news plus earnings momentum has already seen S32 share price well supported. We maintain our Hold rating with a (login to view) target price.

Price catalysts

Completing Sierra Gorda acquisition. Aluminium and coal price momentum.

Risks

COVID-19 risk to metal demand drivers remains key.

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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.

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