2023-04-24 15:04:11 ET
Summary
- South32 Limited's guidance on production, operating expenses, and capital return suggests that the company's short-term financial outlook is pretty favorable.
- The company might be able to capitalize on improving Australia-China ties to hasten the pace of coal asset sales.
- I maintain my Buy rating for South32, as I think that the company has a bright future.
Elevator Pitch
I still rate South32 Limited ( SOUHY ) [S32:AU] stock as a Buy.
My prior write-up for South32 published on December 6, 2022, touched on the "multiple value-unlocking levers" for the stock. I discuss South32's short-term prospects and potential catalysts in the current article. The company's 2H FY 2023 (YE June 30) outlook in terms of costs and production volume is reasonably good, and the time line for the planned divestment of its coal assets might be shorter than expected. These positive factors for South32 support my view that the company's future is bright, which justifies a Buy rating for the stock.
Readers should note that they have a choice of investing in either South32's OTC (Over The Counter) shares with the SOUHY ticker or the company's Australia listed shares with the S32:AU ticker. The average daily trading values for South32's shares traded on the OTC market and the Australia Securities Exchange were approximately $1 million and $50 million, respectively, for the last three months (source: S&P Capital IQ) . In other words, both South32's Australia- and OTC-listed shares have reasonably good trading liquidity. Interactive Brokers is among the U.S. brokerages that allow for trading in foreign markets like Australia, which can used for trading in South32's Australian shares.
South32's Favorable Guidance
South32 recently released the company's quarterly business update for Q1 2023 (calendar year) or Q3 FY 2023 (fiscal year ended June 30) on April 23, 2023. It offered positive read-throughs for its short-term business outlook. As per its most recent update issued in late-April, South32 maintained its production and expense guidance for full-year fiscal 2023.
South32's FY 2023 production guidance implies a reasonably good +6% YoY production volume growth for South32 in the second half of FY 2023 (January 1, 2023 to June 30, 2023). At the company's 1H FY 2023 earnings call (event transcript sourced from S&P Capital IQ ) in mid-February this year, South32 attributed the positive expectations for production growth in 2H FY 2023 to "the Sierra Gorda (copper mine's 45% stake) acquisition (in Feb 2022), the increased stake at Moza (from 47.1% to 63.7% done in May 2022)" and "general improvement projects." Separately, South32 revealed in its Q3 FY 2023 business update that "improved market conditions supported higher prices across most of our commodities" on a QoQ basis. A combination of favorable pricing and production volume expansion is expected to drive meaningful revenue growth for the company in the current interim period.
The company also indicated in its Q3 FY 2023 business update that no changes have been made to the company's existing cost guidance first issued in the middle of February 2023 when South32 announced its 1H FY 2023 results. In its 1H FY 2023 results release, South32 highlighted that the company's "FY23 operating unit cost guidance has been lowered or held largely unchanged for the majority of our operations." It is reasonable to assume that stable or declining operating expenses coupled with higher top line translate into an improvement in South32's profitability for 2H FY 2023.
The current sell-side's consensus financial projections for South32 (source: S&P Capital IQ ) point to the company's revenue and EBITDA increasing +43% and +35% to $5,302 million and $1,835 million, respectively in HoH (Half-on-Half) terms for 2H FY 2023. Considering the outlook relating to production and costs, the expected growth in South32's revenue and operating earnings for the second half of the current fiscal year appear to be realistic and achievable.
It is also worthy paying attention to South32's stance on returning excess capital to the company's shareholders. South32 emphasized at its 1H FY 2023 results briefing in February that it doesn't "plan to hold excess cash" and is exploring various options "to get that excess cash back to our shareholders." In my view, the company's comments on capital management and capital return imply that an increase in ordinary dividends, share repurchases, special dividend pay-outs are among the potential avenues of shareholder capital distribution which could act as re-rating catalysts for the stock.
Divestment Of Coal Assets Could Potentially Happen At A Faster Pace
South32 still had around 30% of the company's EBITDA for 1H FY 2023 generated from metallurgical coal assets. It is very likely that South32 will be able to trade at a higher valuation multiple, if the company's exposure to metallurgical coal assets declines.
Notably, South32 is keen on selling its coal assets, but geopolitical issues have had a negative impact on the company's portfolio restructuring plans. At its 1H FY 2023 earnings briefing, South32 mentioned that "the timing (of coal asset divestitures) is going to be better over the next 6 to 12 months versus the last 18 months" because "of the change in relationship between China and Australia." Specifically, South32 noted that "the Chinese" are the key parties with "a lot of interest in met coal" and "Australia" in recent times. In other words, the company is suggesting that buyers from China, the ones who are most probably able to acquire substantial coal assets and pay a reasonably attractive price, have pulled back on investments in Australia due to geopolitical tensions.
Recent news flow suggests that ties between Australia and China are getting better, which paves the way for further Chinese investment in Australian assets like the coal mines that South32 owns. A March 30, 2023 news commentary published in Chinese state media China Daily cited comments from China's "vice-minister of commerce" that "China is willing to work with Australia to find constructive solutions to related (trade) issues." Reuters published an article on April 11, 2023 that China is reconsidering the current tariffs for barley imported from Australia. Also, Australian media The Sydney Morning Herald's April 18, 2023 commentary piece indicated that there has been an increase in the number of Australian politicians and corporates visiting China recently.
As ESG (Environmental, Social And Governance) becomes an increasingly important investment consideration for investors, companies like South32 with a meaningful exposure to coal assets are being accorded a hefty valuation discount. Assuming that South32 can speed up the process of selling its coal assets on the back of the improvement in ties between China and Australia, the ESG valuation discount for the stock could potentially narrow. One of the assets potentially up for sale is South32's 50% stake in "Eagle Downs metallurgical coal project in Queensland, Australia," as reported in industry publication Mining Weekly .
Closing Thoughts
I take a positive view of South32 Limited's favorable guidance for the second half of this fiscal year and the management's positive expectations of acceleration in coal asset sales. As such, I see no reasons to change my Bullish or Buy rating on South32 Limited stock.
For further details see:
South32: A Bright Future