South32 Limited

Substantial Improvement in Net Cash in March 2019 Quarter: South32 Limited (ASX: S32)is a globally diversified mining and metals company, engaged in the production of bauxite, alumina, aluminium, energy and metallurgical coal, manganese, nickel, silver, lead and zinc. The company operates in Australia, Southern Africa and South America. Recently, the company updated about its Buy-Back Plan that as per its 27 March 2017 buyback scheme, the group has bought back a total of 299,125,490 shares via on-market trade for the total consideration of $941,512,225 till 16 May 2019. The group intends to buy back remaining shares with an aggregate consideration up to USD $56,661,733.

The company in thequarterly report of March 2019, reported that the net cash increased from US$48 million to US$726 million, despite an increase in working capital and the allocation of a further US$37 million to the on-market share buy-back scheme in the quarter.


1H FY19 Key Financial Results (Source: Company Reports)

1H FY19 Financial Performance: On the financial performance front, the revenue of S32 increased to US$ 3,811 million in 1HFY19 from US$ 3,494 million in the prior corresponding period, an increase of 9.0%. The statutory profit after tax of the group increased by 17% to US$635 million in H1 FY19, with the underlying earnings increasing by 18% to US$642 million. This substantial increase in profitability was mainly driven by strong production, higher commodity prices and disciplined cost control. The per unit operating costs of the company benefitted from weaker producer currencies, however, total costs rose with higher production and price-linked royalties, higher raw material costs across the aluminium value chain and an increase in maintenance costs at Worsley Alumina.

The company experienced an improved net margin and operating margin of 16.7% and 23.8% in 1HFY19, an increase of 120 bps and 450 bps over the prior corresponding quarter, respectively. The ROE improved marginally by 60 bps to 5.9% during the period, however the asset-turnover ratio increased by 6.4% to 0.25x in 1HFY19. 

The net cash balance of the company stood at US$678 million having generated free cash flow from operations, including distributions from the manganese EAI, of US$718 million. In line with the commitment of the company to maintain an investment grade credit rating, Standard and Poor’s and Moody’s reaffirmed their respective BBB+ and Baa1 credit ratings for the Group.

The capital management framework of the company remains unchanged and the company continues to believe that a combination of high operating leverage and undue financial leverage will make the returns for the shareholders sub-optimal. The capital management framework has allowed South32 to return US$2.4 billion to shareholders in respect of the last three years, which represents 20% of the market capitalisation of the company. The company will continue to return any excess capital to shareholders in a timely and efficient manner along with a check on the financial position within the context of the prevailing macroeconomic environment and the capital management framework.

Company Guidance: The company has reduced production guidance at South Africa Energy Coal, including low margin domestic production by 2Mt and export production by 0.8Mt. This is primarily, on the back of community protests and a slower than expected ramp-up of activity at Klipspruit. However, the management expects the business to remain on track and achieve FY19 production guidance at Illawarra Metallurgical Coal. The company has lowered its unit cost guidance given the operating discipline and benefit from a stronger US dollar. The stock has yielded a YTD return of 8.12%. It is currently trading at a PE multiple of 8.990x with a market capitalization of $17.71 billion. By looking at improving financials in 1HFY19 and current trading level, we, therefore, reiterate our “Hold” recommendation on the stock at the current market price of $3.520.    

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