South32

About the author:

Author name:

By Adrian Prendergast

Job title:

Senior Analyst

Date posted:

26 August 2016, 9:52 AM

Sectors Covered:

Mining, Energy

Key points

• South32 (S32) continues to impress with its exceptional bottom-of-the-cycle free cash flow performance and superior strategy of maintaining balance sheet strength.
• While not exposed to any of our preferred commodity exposures, S32 has flexed its portfolio of mature assets to post impressive returns.
• S32 finished FY16 with net cash of US$312m.

Earnings performance

A positive surprise, strong cost-out gains saw S32 comfortably beat its cost savings guidance and outpace our EBITDA estimate (actual US$1.13bn vs Morgans US$1.0bn). Underlying NPAT was below our estimate at US$138m (vs Morgans US$175m), while reported NLAT was in line at -US$1.62bn after impairments reported in the first half against the company's manganese and coal assets.

Capex-lite outlook

Despite the lower earnings, S32 maintained an impressive bottom-of-the-cycle cash flow performance. Free cash flow for FY16 of US$597m saw S32 shift its balance sheet into a net cash position of US$312m (vs a net debt balance in FY15 of US$402m). We expect this balance to swell over the coming years, particularly if commodity prices continue to recover. S32 aims to be disciplined and predictable, and supporting this goal we have so far found it difficult to pick holes in the company's capital management and operational strategy which has seen S32 gain a prominent sector position.

From a position of strength

Instead of compromising the strong financial position built up through conserving capital resources generated from its portfolio of mature assets, S32 stressed it would progress slowly when considering adding new growth prospects. A prime example being a cheap option S32 picked up in FY16 to earn into some grassroots (Cu-Ni-PGM) exploration ground in northern Quebec, which it opted for rather than paying a large premium upfront to pick upfront to pick up producing copper assets.

Investment view

While not exposed to any of our preferred commodities, we believe the bottom-up investment case for S32 is so strong that it is one of our top picks in the Australian mining sector, due to:

• balance sheet strength;
• quality of assets (generally); and
• earnings and valuation leverage to a rising commodity market.

The key risk to our call remains commodity price risk and sovereign risk. We retain our Add recommendation with an increased share price target.

More information

Morgans clients can login to view our upgraded share price target and further detailed analysis on South32 (S32). Alternatively, contact your nearest Morgans office for more information.

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.