South32: Cycle acceleration offsets Hermosa slowdown
About the author:
- Author name:
- By Adrian Prendergast
- Job title:
- Senior Analyst
- Date posted:
- 18 January 2022, 10:00 AM
- Sectors Covered:
- Mining, Energy
- A mixed update with increases in schedule and expected capex/opex for Hermosa, while operating scale and long-term base metal outlook both move higher.
- Unlike much of consensus we were already valuing Hermosa using a conceptual DCF, leading to a small net change to our valuation post the Taylor Deposit PFS.
- Nearby prospectivity could see upside risk to Hermosa valuation.
- South32 (ASX:S32) remains a top sector preference, enjoying a support upcycle in metal prices. Maintain our Add rating, with upgraded (login to view) target price.
Hermosa update: Taylor Deposit PFS & Clark Scoping Study
S32 released the results from the Taylor Deposit Pre-Feasibility Study (PFS) and Clark Deposit Scoping Study.
The largest highlight was the size of the increase in development capex. PFS estimates for the development of Taylor’s came in at ~US$1.7bn, 70% above where we estimate consensus to sit (based on Visible Alpha data). The change was attributed to increased scope of dewatering and industry-wide cost inflation.
Production-related expenses on balance came in close to our early assumptions. Based on Arizona estimates, comparable projects and our assumptions, we had been expecting mining cost of US$45/t (vs PFS estimate $35/t), processing cost of $15/t (vs PFS $13/t) and G&A of $2/t (vs PFS $10/t). While other opex ($23/t vs MorgE $8/t) was well above our expectations.
A solid positive in the PFS was the increased throughput, now estimated at 4.3mtpa, vs original Stage 1 of 3.3mtpa. Also, other nice positives in the Taylor’s PFS were higher mill recoveries and metal payabilities than we had assumed.
In terms of timing, management acknowledged that COVID and dewatering have combined to push out the schedule for developing the Taylor’s Deposit. With the project acquired in 2018, progress has been slow with S32 only completing the PFS in early 2022. First ore is now expected in 2027 (vs MorgE ~2025).
The Clark Deposit Scoping Study meanwhile has highlighted potential for a separate development that could see battery-grade manganese produced.
S32 is hopeful that regional exploration could unlock value upside that reverses the decline delivered from budget and schedule slippage. In particular S32 is excited about the nearby Peake and Flux Prospects.
The deterioration in Hermosa fundamentals is disappointing. Especially such a large increase in capex budget. But the ultimate impact to our investment view is small – and offset by the continuing earnings upgrade cycle across metals.
Forecast and valuation update
We have updated our Hermosa DCF to reflect the PFS estimates for Taylor’s. While not including any value for the Clark Deposit or regional exploration targets.
We have applied upgraded house commodity price forecasts (summary further) which has seen a net increase in our S32 target price to (login to view).
S32 is one of our most preferred mining sector exposures.
We see S32 as holding superior commodity and geographical diversification (especially after exiting South African thermal coal), impressive earnings momentum across several segments, attractive earnings power (group EBITDA ~50%), solid near-term dividend (+5%), and an affordable EV/EBITDA of 4.4x FY23F (vs BHP/RIO/FMG on 6.2x/6.4x/7.4x)
We maintain an Add rating with a valuation-derived target price of (login to view).
Q2’FY22 and 1H’FY22 highlighting continuing strong spot fundamentals.
Updates on Sierra Gorda.
COVID related risks to operations and demand drivers for metals.
Execution risk around growth.
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