Morningstar | Robust 4Q for South32; FVE Maintained
We maintain our AUD 2.70 per share fair value estimate for no-moat-rated South32. Lower spot zinc and lead prices have offset the benefit of the higher spot nickel price and slightly stronger near-term forecasts for thermal and coking coal. In addition to Cannington, the outstanding bid for Canada-listed Arizona Mining, which should succeed, has increased South32’s exposure to lead and zinc. Both commodities sold off with the recent correction in base metals prices, bought on by market concerns about trade barriers and the potential for global economic growth to slow.Despite the decline in lead and zinc prices, we still think the acquisition of Arizona Mining is likely to add value to South32. Assuming a nominal price of USD 1.25 per pound for zinc and USD 1.06 per pound for lead, Arizona should add about AUD 0.11 per share to our fair value estimate. In addition, once developed, the Taylor deposit brings a long-life, low-cost mine. The acquisition modestly improves the overall quality of South32’s portfolio.
Despite this, South32’s shares remain overvalued. We are concerned about the outlook for steelmaking raw materials, given that China’s consumption is likely to decline, and scrap should take a growing share of production. Coking coal and manganese prices trade well above cost curve support. The thermal coal price is also very strong, but should normalise, given that a supply response is likely to be induced.
Fourth-quarter 2018 production was robust. Full-year output exceeded guidance at Cannington, Cerro Matoso, and Illawarra coal. Admittedly, guidance for the Illawarra coal and Cannington operations was meaningfully lowered through the year, but improvement in the fourth quarter gives confidence that output can recover to more normal levels. South32’s other operations generally met production guidance, with alumina a modest exception. Overall, our adjusted fiscal 2018 earnings forecast rises modestly to AUD 0.39 per share from AUD 0.37.
South32 is engaged in mining and metal production from a portfolio of assets for the commodities of alumina, aluminium, bauxite, energy and metallurgical coal, manganese ore, manganese alloy, nickel, silver, lead and zinc. As of June 30 2016, Co. operated 10 segments, which were comprised of: Worsley Alumina, South Africa Aluminium, Brazil Alumina, Mozal Aluminium, South Africa Energy Coal, Illawarra Metallurgical Coal, Australia Manganese, South Africa Manganese, Cerro Matoso, and Cannington.
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