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Morningstar | South32 Benefits From Buoyant Manganese and Alumina Prices, but Shares Remain Overvalued

No-moat rated South32 delivered solid first-half 2019 results with 18% growth in adjusted net profit to USD 642 million versus the same period last year. The performance was largely driven by record production in Australia Manganese and higher commodity prices. Underlying EBIT grew 28% to USD 925 million, with higher prices adding USD 223 million and volumes USD 216 million versus a year ago. Production guidance is unchanged and output at South32 is tracking in line with our expectations. In its updated guidance, management generally lowered unit costs to reflect favourable currency changes. Fiscal 2019 capital expenditure guidance was also modestly reduced. However, the lower costs are not sufficient enough to alter our AUD 2.80 per share fair value estimate.

The balance sheet is in good shape with about USD 700 million net cash, however, capital management is still a focus. South32 declared an interim dividend of USD 5.1 cents per share and special dividend of USD 1.7 cents per share, both fully franked and broadly in line with the first half of fiscal 2018. South32 returned USD 511 million to shareholders in the half through dividends and buy-backs. Of the company's USD 1 billion capital management program, USD 127 million remains to be returned to shareholders by April 10.

South32 remains overvalued. Commodity prices remain the key driver of shareholder returns. Many of the company’s key commodities trade well above our estimated long-term marginal cost, namely manganese, alumina, and metallurgical coal, suggesting earnings are above sustainable levels. Further, continual expenditures are needed to offset depletion and the cyclical and capital intensive nature of the industry adds risk. Buoyant commodity and share prices do not reflect our view that China’s economic growth will shift toward less commodity consuming activities, which will drive down prices.