SOUHY - South32: Put It On Your Watchlist

Summary

• South32 had a great 2022 with high production and rising commodity prices.
• Cyclical tailwinds and new mining operations will drive growth.
• The company faces risks from government intervention but is focused on ESG.

Summary

South32’s stock (SHTLF) (SOUHY) price has risen by 15% YTD. South32 benefits from cyclical tailwinds from the aluminum market and has new expansions on the books. Its stock is also trading at a reasonable valuation. However, there is resistance to the company due to the growing climate change activism within the Australian Government which might harm the company. Still, the company is trying to improve its ESG. With all this in mind, we are placing a “Hold” rating on the stock to see how its expansions pan out as well as how much its ESG improves.

Company Financials Overview

South32 is an Australian multinational metals and mining company. It mines and produces bauxite, alumina, aluminum, copper, silver, lead, zinc, nickel, metallurgical coal, and manganese from its operations in Australia, South Africa, and South America. With a focus on growing its base metals exposure, it also has two development options in North America and several partnerships with junior explorers around the world. The majority of its revenue comes from its aluminum and metallurgical coal production.

From 2021 to 2022, South32 has shown solid financial growth. During this time period, South32’s revenue increased by 69% and net profit increased by 86%. In addition, the net profit margin increased from 60% to 66%. Revenue by country is spread out evenly with the only notable exception of the Netherlands and Australia making up 24% of revenue. Overall, South32 had an excellent year helped by improved production and rising commodity prices.

Tailwinds

State of the Aluminum Market

The aluminum market shows ample room to grow. Due to the increased use of aluminum over stainless steel for electric vehicles and original equipment managers, the aluminum market is projected to hit around $277.5 billion by 2030, growing at a compound annual growth rate ((CAGR)) of 5.61% from 2022 to 2030. Furthermore, the growth in the aluminum market could be even greater due to expansion in the EV market, a major consumer of aluminum.

Exploration and Projects

Here are the projects South32 is working on.

- Farm-in agreements with Encounter Resources for projects in the Northern Territory, Australia.

- A strategic alliance with AusQuest to develop a pipeline of high-potential exploration opportunities such as copper, zinc, and nickel projects in Australia and Peru.

- An agreement with Adventus Mining Corporation to advance a series of carbonate-hosted, 'Irish Type', zinc, lead-silver projects in Ireland.

- A regional strategic alliance agreement with Bronco Creek Exploration to focus on copper and other base metal projects in Arizona, New Mexico, and Utah in the USA.

- An earn-in agreement with Minsud Resources to explore the Chita Valley, copper, molybdenum, silver, and gold project in Argentina.

- An earn-in agreement with Sable Resources to explore Argentina's Don Julio copper and gold project.

- Advancing internally generated base metal exploration opportunities in Australia and the Americas.

Each of these projects is anticipated to even further expand on South32’s extensive global operations and ensure the supply to exploit projected growth in metals markets

Risk

Growing Green Party in Australia

Over the past couple of years , the Australian Green Party has significantly grown in popularity. With the party citing ecological sustainability as a core value , they could prove to be a problem for South32. For example, its dendrobium metallurgical coal mines extension project in New South Wales faced pressure from the Australian Greens Party which attempted to push for the extension to be rejected by the government. Cate Faehrmann, a Greens MLC said it was “unthinkable” that the expansion could have ever been approved because it would have put catchments at risk at a time of more significant threat to water security due to the climate crisis. With the ongoing growth of the Australian Greens party, South32 could continue to face resistance to their plans which poses a significant risk to its business model.

Valuation

On January 24, both analysts from Citigroup and the Royal Bank of Canada reiterated their buy rating on South32. Currently, 7 out of 12 other Wall Street analysts have placed buy ratings on the stock, and the average price target is 8% above the current market value. Currently, it's also trading at a 4.81x P/E, which is near historic lows. Overall, it seems that South32 is trading at a reasonable valuation.

ESG

South32 is now, more than ever, focused on decarbonization. In August 2022, it announced that it had pulled back from its initial $700 million upfront investment to extend its Dendrobium metallurgical coal mine in New South Wales, instead shifting its focus to "metals critical to a low carbon future."

Even with this, though South32 does have plans to be more climate-friendly like in their Climate Change Action Plan , however, it hasn’t been meeting many of the criteria set.

Conclusion

South32 is worthy of being placed on investor’s watchlists, as the company has shown solid performance and benefits from cyclical tailwinds. In addition, it’s also trading at a reasonable valuation with many analysts seeing an upside. However, it faces significant risks with governments as well as its ability to meet ESG demands. For those reasons, we currently place a “Hold” rating to see how it navigates ESG issues as well as the development of its new projects.

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