South32: Costs fail to take shine off

About the author:

Author name:

By Adrian Prendergast

Job title:

Senior Analyst

Date posted:

26 August 2022, 8:00 AM

Sectors Covered:

Mining, Energy

• A strong result from South32 (ASX:S32), very close to consensus expectations, including a bumper final dividend that included a US3 cent special dividend.
• S32’s final dividend impressed, announcing a US14 cent ordinary and US3 cent special dividend. With S32 returning 10% of its market cap in FY22.
• Despite material increases in unit costs, S32 still reported operating margin growth across all segments (ex-Cannington).
• Earnings multiples are regularly inconsistent value indicators in resources, but in S32’s case we believe it shows the market is misjudging how much residual earnings power will remain in the business post cycle peak.
• Boasting strong cash flow, dividend profile and balance sheet. We maintain an Add rating with a (login to view) target price.

Solid FY22 as expected

Strong FY22 result overcoming cost pressures. Dead inline with the street. 

Underlying EBITDA US$4,755m, which was +155% vs pcp, and inline with a Vuma consensus average of US$4,778m and just ahead of our estimated US$4,629m. 

EBIT also inline at US$3,967m (vs consensus US$3,989m vs MorgansE US$3,868m). 

FY22 underlying NPAT of US$2,602m was +436% vs FY21, while inline with consensus US$2,576m and a touch behind our US$2,810m.

S32 posted an impressive ROIC for FY22 of 30%, vs 6% in FY21. 

As expected S32 flexed its final dividend, with a US14 cent ordinary plus a US3 cent special dividend. FY22 DPS of US25.7 cents (vs consensus US25.8 cents).

Analysis

We expect FY22 was a peak year for earnings. With FY23 likely to see more moderate metal prices and higher persisting unit costs as per FY23 guidance. Although even allowing for this we still see S32’s current share price as implying the miner is trading on just ~3x EBITDA.

Not going ahead with some coal developments in our view could also be part of a portfolio move with S32 having made no secret that it prefers base metals.

Forecast and valuation update

We have adjusted our FY24 production forecasts inline with guidance.

Lifted unit cost assumptions across S32’s alumina, aluminium, Illawarra (coal) and Sierra Gorda (copper) operations post the FY22 result.

Net of these changes our valuation-based target price has been revised to (login to view), still at a healthy margin above S32’s current share price.

Investment view

Looking at multiples (especially earnings) for resource stocks is dangerous given how regularly they break their relationship of being a value indicator.

However at the moment, in S32’s case, we believe the ~3x forward EBITDA multiple is suggesting that the market has not paid an adequate valuation for the residual earnings strength the diversified miner is likely to maintain, even if FY22 was a peak year.

With the market seemingly mispricing S32’s solid cash flow, healthy dividend profile, and strong balance sheet, we maintain our Add rating.

Price catalysts

• 1Q24 operational result. 
• Sierra Gorda debottlenecking.
• Potential new M&A.

Risks

• Geomacro risks to global growth (i.e. metal demand drivers).
• COVID-19 risks to operations and end markets.

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