South32: China COVID fears uncover value

About the author:

Adrian Prendergast
Author name:
By Adrian Prendergast
Job title:
Senior Analyst
Date posted:
27 April 2022, 10:00 AM
Sectors Covered:
Mining, Energy

  • A mixed 3Q22 quarter from South32 (ASX:S32), with some production beats/misses and some predictable increases to unit cost guidance.
  • The downgrades to FY22 unit cost guidance across several assets were largely within arm’s reach of our estimates, leading to minor adjustments to estimates.
  • S32 finished 3Q22 in a net cash position of US$52m, despite completion of the US$1.4bn Sierra Gorda 45% interest acquisition.
  • Largest factor remains strong metal prices, applying updated Morgans price forecasts leading to a net increase in valuation.
  • We maintain our Add rating, with an upgraded (login to view) price target on higher met coal prices.

Mixed but reasonable 3Q22 result

On balance a reasonable 3Q22 result for S32, with the diversified miner managing a reasonable production performance whilst containing broad cost pressures.

Ali division did well. Solid 3Q22 from the ali division, with steady alumina production of 1,317kt (vs Visible Alpha consensus 1,300kt vs MorgE 1,331kt) supported by a strong performance from Worsley at 982kt (vs consensus 960kt vs MorgE 987kt). Alumar was in line at 335kt.

Meanwhile, group aluminium output was close at 243kt (vs consensus 249kt vs MorgE 251kt). Importantly, S32 did not experience any demand destruction unlike some offshore peers where customers were constrained by supply chain bottlenecks. 

Illawarra mixed. Met coal production of 1,565kt (vs consensus 1,621kt vs MorgE 1,526kt) was close to estimates, recovering from wet weather, while thermal coal volumes out of Illawarra dipped unexpectedly (216kt vs consensus 267kt vs MorgE 269kt) with S32 flagging Illawarra’s lower quality thermal coals were uneconomic against current high freight rates. Cost guidance downgraded on AUD.

Cannington impresses. A strong performance, with higher grades and ROM inventory rundown leading to higher silver output of 2,953koz (+21% vs consensus) and lead production of 34.6kt (+20% vs consensus), while zinc trailed at 16.4kt (- 5% vs consensus). Cost guidance downgraded on AUD and royalty expenses. 

Cerro Matoso. S32’s Columbian nickel operation produced 10.6kt of nickel (vs consensus 11.2kt vs MorgE 11.8kt), which trailed estimates but remained at high levels enjoying good grades out of the Q&P pit. Unit cost guidance also lifted.

Manganese mixed. GEMCO impressed with manganese ore production of 815kt (vs consensus 761kt vs MorgE 788kt), although South African manganese ore fell short of expectations at 391kt (vs consensus 479kt vs MorgE 495kt).

Sierra Gorda. First contribution from S32’s copper interest, producing 9.7kt CuEq.

Guidance. No changes to production guidance. S32 did downgrade FY22 unit cost guidance across several segments (summary further) due to a number of factors like FX/raw material costs. These changes were close to our expectations.

COVID surge in China a growing short-term risk

It is impossible to ignore broader market fundamentals, with a China COVID surge the latest top-down factor driving metal markets.

The escalating COVID situation in China is of some concern to us, dampening our short-term demand expectations and currently triggering a risk-off trade from investors that has the resource sector under pressure (in particular base metal miners).

Forecast and valuation update

The largest change to our estimates comes from applying updated house metal price forecasts, in particular met coal and nickel prices. We have also made minor adjustments to FY22 production estimates with one quarter remaining.

These changes have seen a net increase in our valuation to (login to view).

Investment view

The top-down risks increase our caution for more active investors, who should adjust their short-term expectations, while for value investors we view the current sell off as creating an opportunity to accumulate our top sector picks (like S32) at more attractive levels. We maintain our Add rating.


Key risk to our call remains the COVID-19 risk to commodity demand and operations.

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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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