SOUHY - South32: Watch Capital Return And Capital Recycling Catalysts

2023-09-15 12:47:57 ET

Summary

• South32 Limited's stock has underperformed recently because of its FY 2023 earnings miss.
• But there are catalysts pertaining to capital recycling and shareholder capital return that might support a recovery in the South32 Limited share price.
• I maintain my Buy rating for South32, in consideration of potential re-rating catalysts.

Elevator Pitch

I rate South32 Limited ( SOUHY , S32:AU) stock as a Buy.

My earlier July 7, 2023 write-up highlighted that South32 is "a play on decarbonization" with good "balance sheet strength." In the latest article, I note that there are two key catalysts that could drive SOUHY's share price recovery going forward. Firstly, South32's actual capital return in the form of buybacks and dividends might surprise the market in a positive way. Secondly, South32 has the potential to rely on capital recycling to boost shareholder value. As such, I retain a Buy rating for South32.

It is relevant for readers to know that South32's shares are traded on the Over-The-Counter or OTC market and in Australia. The company's shares listed on the Australian Securities Exchange and the OTC market boasted daily trading values of $40 million and $1.5 million, respectively for the past three months as per S&P Capital IQ data. U.S. stockbrokers with access to international equity markets like Interactive Brokers can facilitate trading in South32's shares listed in Australia.

Share Price And Valuation Multiples

SOUHY's stock price declined by -12.9% for the past month. In the same time frame, the S&P 500 (SP500) was still in positive territory with a +0.3% gain.

South32's shares took the biggest hit in the days following the company's full-year fiscal 2023 financial results announcement in the latter part of the previous month. Specifically, SOUHY's share price dropped by -5.3%, -3.9%, and -1.1% , on August 24, August 25, and August 28 this year, respectively.

The company's actual FY 2023 core earnings of $916 million were -6% below the sell-side analysts' consensus bottom line projection of $973 million due to "sluggish demand from top metals consumer China" as indicated in Seeking Alpha News' August 23, 2023 article .

South32's share price underperformance in the recent month is justified by its FY 2023 earnings miss. But I am of the opinion that there are catalysts that might drive a strong recovery in SOUHY's stock price in time to come.

Shareholder Capital Return

The market is worried that South32's future shareholder capital return could fall short of expectations. Australian stockbroker Morgans Financial noted in an earlier July 2023 research report that it sees South32's dividend to be "at risk." Separately, UBS ( UBS ) mining sector sell-side analyst Myles Allsop questioned at the company's FY 2023 earnings call whether South32's future share repurchases will be affected assuming that "net debt continues to creep up."

There are signs indicating that analysts' concerns regarding South32's capital return initiatives like dividends and buybacks are overdone. If South32 continues to maintain a healthy dividend payout ratio and executes on share repurchases, fears relating to the company's capital return are likely to ease, which should push up SOUHY's stock price in the future.

Even though South32's FY 2023 results were below expectations as noted in the preceding section of the article, the company stuck with a 40% dividend payout ratio in the current fiscal year, which was the same as what it did in the previous fiscal year.

On the other hand, South32 expanded the company's existing share buyback plan by an additional $50 million when it released its FY 2023 results in August. Also, the company has begun buying back its own shares again in September after its full-year earnings announcement. South32 repurchased a total of about 2.8 million of its own shares on September 12 and September 14 , respectively.

It is very encouraging to see that South32 remains committed to shareholder capital return, especially share buybacks since its shares are undervalued. As per S&P Capital IQ's consensus data, South32 is now trading at 4.6 times consensus forward next twelve months' EV/EBITDA.

Capital Recycling

There is nothing that South32 can do to influence commodity prices and demand, so it is inevitable that its financial performance will be very much affected by the global economy's impact on commodity markets. Instead, South32 should focus on capital recycling to improve the quality of its asset portfolio, which is likely to serve as a re-rating driver for the stock.

South32 emphasized at its FY 2023 earnings briefing that "everything (within the company's portfolio) is for sale at the right price" based on the company's goal to "create value for shareholders." In particular, SOUHY's Illawarra Metallurgical Coal, Australia Manganese, and South Africa Manganese projects were deemed to be assets that had the potential to be divested, as per the sell-side analysts' questions at the full-year analyst briefing.

Proceeds derived from asset divestitures can be either utilized for shareholder capital return initiatives like repurchases and dividends, or used to finance acquisitions to optimize South32's asset portfolio.

At the company's most recent fiscal year results call, SOUHY stressed that its portfolio is "tilting more and more towards future-facing commodities" with "a bias to towards the base metals" as "the world decarbonizes." South32's previous purchase of a 45% interest in Chilean copper mine asset, Sierra Gorda , serves as an example of the kind of base metal projects that the company has a keen interest in.

An increase in the quality of SOUHY's asset portfolio driven by capital recycling initiatives should allow South32 to command a higher valuation multiple.

Closing Thoughts

My Buy rating for South32 Limited stays unchanged. The company's shares have done poorly in the past one month, but there are re-rating catalysts that could provide support for a stock price recovery in due course.

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