South32: Q1 trails expectations

Author name:: By Adrian Prendergast
Job title:: Senior Analyst
Date posted:: 25 October 2022, 8:30 AM
Sectors Covered:: Mining, Energy

A mixed quarter operationally for South32 (ASX:S32), not the kind of start to the year we were expecting.
Solid copper and manganese volumes, outpacing consensus estimates.
Coal, alumina, zinc and nickel production all trailed market estimates.
Slow start to the year but S32 remains in robust shape, with clear exposure to a recovery scenario for China growth.

Soft start in 1Q23

A busy first quarter which on balance was on the softer side. S32 posted solid volumes from Sierra Gorda (copper) and GEMCO (manganese). While Illawarra (coal), Worsley (alumina), Cannington (zinc/lead/silver) and Cerro Matoso (nickel) all came in below Visible Alpha consensus for 1Q23.

Full recap further in report.

Analysis

In terms of what we learned:

Illawarra and Cannington remain prone to volatile performances.
Worsley and Cerro Matoso had planned maintenance activities that we/consensus were not aware of with output now expected to be second half skewed.
Sierra Gorda is starting to demonstrate it has the ability to lift copper output beyond the kinds of levels posted in its early life (with the JV working on further debottlenecking to reach throughput of ~50mtpa (100%) this quarter).

From the negatives, Illawarra in particular remains tricky operationally and environmentally, with 1Q23 impacted by a delay to the latest longwall move and industrial action at the Appin mine. We expect S32 might have interest in divesting Illawarra, which is enjoying near cycle high prices, but this would not be made any easier by what we see as a disappointing track record from the operation.

The best positive in our view was Sierra Gorda’s performance. The recent acquisition was done in our view at a reasonable price, but we had lingering question marks over the mine’s performance in recent years.

These concerns are being addressed with the joint venture showing that not only is the mine now a steady producer, but also that extra tonnes can be unlocked from debottlenecking. S32 still expects to reach nameplate of ~50mtpa (100% in 2Q23).

We expect S32 to continue transitioning its portfolio further towards base metals, with a strong balance sheet supporting potential for further M&A.

Forecast and valuation update

We have updated our FY23 production forecasts, allowing for greater second half skew across several mines, with S32 getting off to a slow start to the year but only trimming expected met coal volumes.

We have also added in additional opex to Illawarra to account for maintenance.

Net of these changes our valuation is adjusted to (login to view).

Investment view

We view S32 as a key large-cap (ex-iron ore) sector pick.

S32’s share price has drifted lower almost in line with softer earnings, maintaining a free cash flow yield in the range of ~15% for FY23F while de-rating in terms of EBITDA multiple (now <3x).

We maintain an Add rating with a revised (login to view) Target Price.

Price catalysts

2Q23 operational result.

Progress at Hermosa (FID/development).

Risks

Key economic conditions (essentially demand drivers for metal prices).

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