South32: Healthy quarter over headwinds

About the author:

Author name:

By Adrian Prendergast

Job title:

Senior Analyst

Date posted:

24 January 2023, 7:30 AM

Sectors Covered:

Mining, Energy

• A steady 2Q23 operational result for South32 (ASX:S32), with most segments ahead or in-line with estimates.
• S32 also managed to keep a lid on unit costs, outside of Cannington which was effected by lower volumes.
• Some build in working capital in 1H23 with some lag in sales volumes. Realised prices broadly in-line with estimates.
• Applying increases to Morgans coal price forecasts results in net increase in TP.
• We maintain our ADD rating, with a (login to view) Target Price.

Good result considering

S32 reported a good relative result given difficult operating environment, with some segments battling persistent cost pressures, weather and/or tight labour markets.

2Q23 production from most segments was in-line or ahead of Visible Alpha consensus and Morgans expectations, with the exception of Cannington (silver - 13%, lead -6%, zinc -8% vs Visible Alpha consensus) due to tight labour and Brazil Alumina (-4% vs consensus) on a slower-than-expected ramp up.

The positives in 2Q23: a) lower weather impact at Illawarra vs coal peers, b) solid manganese ore production at both GEMCO (+14% vs Morgans) and Hotazel (+15% vs Morgans), and c) broadly steady unit cost guidance. 

S32 flagged that unit costs for both Worsley (alumina) and GEMCO (Australian manganese) were expected to be below the guided range in 1H23. While Brazil Alumina, Sierra Gorda, Cannington and Illawarra unit costs are expected to be above their unchanged FY23 guidance ranges. Hillside and Mozal meanwhile are expected to achieve cost savings vs pcp. 

Realised prices reported for 1H23 fell broadly in-line with expectations.

Work on Hermosa (zinc project) in Arizona continues with a final investment decision (FID) expected mid CY23.

Forecast and valuation update

Updated FY23 forecasts post the 2Q23 result and guidance updates. Leading to a 4% decrease in FY23 EBITDA to US$3.56bn (from US$3.69bn).

We have also applied revised coal price forecasts in-line with recent changes to our house assumptions. Thermal coal: FY23F now US$262/t (was US$306/t), FY24F US$270/t (was US$205/t), FY25F US$190/t (was US$128/t).

Hard coking coal: FY23F US$325/t (was US$333/t), FY24F US$251/t (was US$231/t), FY25F US$218/t (was US$176/t).

Post these changes to our estimates our valuation-based Target Price on S32 increases to A$5.60 (was A$5.30).

Investment view

We maintain a positive view on S32. The company offers an attractive mix of raw material and base metal exposures, combined with an effective management team. S32 continues to deploy capital efficiently, while gradually transitioning its portfolio out of trickier assets and into more base metals focus (with acquisitions in copper and zinc).

We see potential for S32 to make further acquisitions, while also possibly seeking to exit coal completely.

Despite the recent share price strength we still see further upside potential on offer as the upcycle in resources continues (while volatility is likely to also remain a feature). We maintain an ADD rating with a (login to view) Target Price.

Price catalysts

• 1H23 earnings result (16 February).
• Progress on Hermosa (FID mid CY23).

Risks

• Global/China macro (metal demand drivers).

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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.