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South32 Ltd – Does the recent plunging gives any bargain buying option?

October 05, 2015 | Team Kalkine
South32 Ltd – Does the recent plunging gives any bargain buying option?

Mineral Resources and Ore Reserves Update:

The latest update by South32 (ASX: S32) entails a 21% rise in total mineral resources at its Cannington operation. The coal resources and coal reserves for Illawarra Metullurgical coal have been upgraded. Further, the Groote Eylandt Mining Company (GEMCO) reported for upgrading of in-situ mineral resources.



 Resource Update (Source: Company Reports)

Results for FY 2015



In announcing the results for the financial year ended 30 June 2015, the company CEO Graham Kerr said that the implementation of the regional operating model and broader cost-saving initiatives are already delivering strong results and over the next three years, the target is a reduction of controllable operating costs by at least $ 350 million per annum. Among the highlights of the financial year is the successful demerger from BHP Billiton on 25 May 2015. Pro forma profit after tax was USD 28 million compared to USD 64 million in the previous year and the underlying earnings were $ 575 million ($ 407 million of previous year). The underlying EBIT was USD 1 billion (as opposed to USD 642 million) and the EBITDA margin was 26% compared to 20% in the previous year. Free cash flow before interest and tax was USD 1.68 billion (USD 974 million) and pro forma productivity led cost efficiencies embedded in FY 2015 totalled USD 282 million. Closing net debt of USD 402 million underpinned the credit ratings of BBB +/Baa1. The underlying return on capital was 6.2% compared to 4% in the previous year. Net tangible assets per ordinary share were $ 2.02 as on 30 June 2015 compared to $ 2.47 in the previous year and the company does not intend to pay a dividend for FY 2015.
 

Financial Highlights (Source: Company Reports)

Revenues came to USD 7.74 billion compared to USD 8.34 billion in the previous year while the profit from operations amounted to USD 519 million compared to USD 319 million in the previous year. Basic EPS works out to USD 0.5 compared to USD 1.2 in the previous year. The basic underlying EPS was USD 10.08 compared to USD 7.6. The operating cash flow in terms of cash generation from continuing operations was USD 1.68 billion compared to USD 974 million. Impairments for the year included an adjustment to the carrying value of the Wolvekrans Middelburg complex in South Africa Energy Coal of USD 551 million pre-tax and the write-off of the Metallic Nickel Recovery Project in Cerro Matoso of USD 41 million pre-tax.
 
The company took operational control of its assets on 1 February 2015 and was successfully demerged from BHP Billiton on 25 May 2015 and the results highlight the continued emphasis on costs and optimisation of capital expenditure. The pro forma underlying EBITDA increased by 26% to USD 1.85 billion as production records were achieved in four assets Illawarra Metallurgical Coal, Australia Manganese, South Africa Manganese and Brazil Aluminium. Pro forma depreciation and amortisation remained largely unchanged. Pro forma underlying EBIT increased by 56% to USD 1 billion. This was due to an increase of USD 282 million in productivity led cost efficiencies and an increase of USD 53 million in contract power sales in Brazil. The combined impact of weaker commodity prices (USD 268 million) and inflation (USD 197 million) were largely offset by the rise of the US dollar against a basket of producer currencies (USD 435 million).



Pro forma Underlying Earnings (Source: Company Reports)
 

Finance and cash flow

Pro forma underlying net finance costs of USD 194 million largely reflects the unwinding of the discount applied to restoration and rehabilitation provisions of USD 120 million and finance lease charges of USD 60 million primarily at Worsley Alumina. Pro Forma underlying income tax expenses were USD 232 million excluding taxation associated with equity accounted investments and this implies an underlying effective tax rate of 28.7%. Pro forma tax expense for equity accounted investments was USD 47 million and royalty related tax expense was USD 30 million in equity accounted investments.

On a pro forma basis, cash generated from continuing operations increased by 35% to USD 1.84 billion. This includes an increase in working capital of USD 114 million due to payments from provisions in excess of the amounts charged partly offset by a decrease in inventory. Pro forma capital expenditure was USD 768 million comprising of stay in business expenditure of USD 578 million, major projects capital expenditure of USD 51 million and share of capital expenditure associated with equity accounted investments of USD 139 million. The Appin Area 9 underground extension at Illawarra Metallurgical Coal is the only major project development. This project is now expected to be completed ahead of schedule and approximately 20% under budget. Capital expenditure associated with the Premium Concentrate Ore project at Australia Manganese and the second phase of the Central Block project at South Africa Manganese is included under the share of equity accounted investments.
 

Pro forma Asset Table (Source: Company Reports)

Outlook

As regards production, the asset base is well capitalised because it has received substantial sums of investment over many years. The strategy includes a deliberate focus on existing assets to optimise performance. Given the diversity of this portfolio geographically and technically, this requires a flexible and entrepreneurial approach. The company will continue to take decisive action as appropriate. For instance, a review of South Africa Manganese is underway, a final decision could involve a further reduction in the production of alloy and ore.
 
The outlook is to continue fast tracking the implementation of the regional operating model and redesigning the way in which the company operates. Further, continuing to reduce controllable costs by an additional USD 350 million every year (including equity accounted investments) or more by the end of FY 2016 is another priority. Other objectives include reducing capital expenditure by 9% to USD 650 million (including equity accounted investment) in FY 2016, distributing a minimum of 40% of underlying earnings as dividends in each six month accounting period and a simple strategy designed to realise the potential of the asset portfolio and deliver long term growth in return on capital employed.
 
The speculation relating to Alcoa’s plans to demerge the upstream and downstream businesses and have some deal-making involving Alumina Ltd, Rio Tinto and South32 is yet to be satiated to see any benefit to S32.
 
Some negative impact is expected to prevail in near term in view of the economic slow-down in China which will hit commodity prices. We still think that despite the continued risk of commodity price volatility, the company has a strong balance sheet to withstand any downturns with a low gearing and more than USD 650 million in cash to sustain in the long term. Moreover, the company has a well diversified asset portfolio and stands to benefit from an upturn in many commodity sectors. We would rate the stock as a Buy at the current price of $1.375.


S32 Daily Chart (Source: Thomson Reuters)

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