2023-07-07 08:58:42 ET
Summary
- South32's portfolio mix optimization efforts in terms of geographical market and commodity exposure will enable the company to grow faster while reducing concentration risks.
- SOUHY is a play on decarbonization, and the company's balance sheet strength gives it the opportunity to utilize M&A as a means of further optimizing its portfolio.
- I continue to have a bullish view of South32, as its valuations remain attractive.
Elevator Pitch
My Buy investment rating for South32 Limited ( SOUHY ) (S32:AU) shares remains intact. I evaluated SOUHY's near-term outlook and potential asset divestiture opportunities in my earlier April 24, 2023 article .
With this current update, I find that the market has failed to reward South32 for its favorable portfolio mix and strong financial position. South32 doesn't deserve to trade at its current mid-single digit EV/EBITDA and high-single-digit normalized P/E valuations. In my opinion, South32's shares are mispriced and deserving of a Buy rating.
South32 has shares listed on both the Australian Securities Exchange and the OTC market. The company's OTC shares with the SOUHY ticker have reasonably good liquidity, with an average three-month daily trading value of more than $1.5 million. Investors who prefer to trade in more liquid shares can consider South32's Australia-listed shares with the S32:AU ticker. South32's shares listed on the Australian Securities Exchange have a relatively higher three-month daily trading volume of over $40 million and can be traded with US brokers such as Interactive Brokers.
South32's Commodity And Geographic Mix In The Limelight
South32 has been optimizing the company's portfolio mix to allow it to leverage on future growth opportunities and also lower its risk profile.
SOUHY's 1H FY 2023 EBITDA Mix By Commodity Type
As per the chart presented, South32 currently has a fairly diversified commodity mix. Apart from the company's legacy metallurgical coal asset, no other single commodity accounted for more than 20% of SOUHY's operating earnings in the most recent interim period.
South32 also disclosed at the BofA ( BAC ) Securities Global Metals, Mining & Steel Conference (event transcript sourced from S&P Capital IQ ) on May 16, 2023 that the company used to have an even or 50-50 split between coal and base metals assets with regard to operating income contribution in the past. But South32 currently derives 70% or more of its EBITDA from base metals. The company has decided that its growth outlook will become more favorable, when its portfolio has more of specific commodities that will be in demand (e.g., base metals) as the world undergoes an energy transition process. Notably, South32 stressed at the BofA investor conference that it is "not planning to grow it or add new metallurgic coal (assets) to the portfolio."
Separately, South32 used to have a significant concentration in the Australian and South African markets, which represented about 85% of its portfolio value as disclosed at the May 2023 BofA investor event. South32 had mentioned at the BofA conference that it has "operated assets in Colombia, Mozambique, South Africa" which it acknowledged was "not the easiest of locations." As such, it makes a lot of sense for South32 to have a more balanced and diversified geographic exposure.
Looking ahead, SOUHY expects to become more diversified geographically in the medium term. In particular, Americas has been a key area of focus for South32 in terms of geographic expansion as indicated in the chart below.
South32's Key Projects Located Across The World
In the subsequent section, I touch on why a potential investment in South32 is one of the ways to bet on a greener world in the future.
Play On Decarbonization
South32 noted at the BofA investor conference in mid-May this year that "the world is going through a transformation" which will "drive unprecedented demand" for "commodities that are used to decarbonize and become greener."
Specifically, SOUHY is now placing a greater emphasis on zinc and copper assets as indicated at the BofA conference, as it believes that both of these commodities have favorable demand-supply dynamics and also benefit from decarbonization. As indicated in the prior section, copper and zinc/lead/silver contributed 13% and 9% of South32's EBITDA, respectively for the most recent interim period.
There are opportunities for South32 to grow the company's portfolio exposure to the decarbonization growth theme. At the BofA investor event, SOUHY acknowledged that lithium was something which the company "got wrong 3 years ago", and it didn't rule out the possibility of acquiring lithium assets assuming there is a price "point (for acquiring certain assets) where we believe we can create value for our shareholders."
In its most recent interim period (1H FY 2023) results presentation , South32 highlighted certain metrics which indicated that the company has the financial capacity to engage in future acquisitions. SOUHY's leverage metric was a mere 0.2 times, and the company has secured investment grade credit ratings from the major rating agencies. Also, South32 has an estimated $3.0 billion worth of liquidity, comprising of cash and a credit revolver.
In a nutshell, SOUHY is a play on decarbonization now, and South32 has the financial strength to further optimize the company's portfolio via M&A activities.
Concluding Thoughts
South32 is currently valued by the market at consensus forward next twelve months' EV/S (Enterprise Value-to-Sales), EV/EBITDA and normalized P/E multiples of 1.4 times, 4.2 times, and 9.0 times (source: S&P Capital IQ ), respectively. I don't think South32 should be trading at such undemanding valuations, taking into account the company's portfolio mix and financial strength. Therefore, I have chosen to stick with a Buy rating for South32.
For further details see:
South32: Decarbonization Play With Good Financial Strength