Demerger of South 32 (S32) from the BHP Billiton was intended to unlock hidden value in the assets the market overlooked as a combined entity. The result is South 32 which is no small picnic which by its size is automatically included in ASX 50, the 50 largest companies listed on the ASX.
S32 Results to be announced on February 26th 2015 and it declared no 2016 dividend.
BHP retained the petroleum, iron ore and potash assets while South 32 included the base metal assets such as lead, nickel and zinc. Energy assets in coal (energy and Meallurgical coal) as well as alumina and precious commodity silver producing assets.
Unlike the banks, we are positive on commodity producers like Rio Tino.
S32 Year to Date Performance
Chart above compares the return of ASX S32 return verses the broader market, as represented by ASX 200 index. As well as BHP and Rio Tinto Shares.
We have gone through the 1000 pages in the demerger information memorandum (IM) and highlighted the critical charts and table that summaries the new entity. Note all charts are from the IM.
It is important to note due to the global nature of S32’s business. As commodities are priced in US exchange rate, this means that fluctuations in the AUD to USD even EUR to AUD exchange rate can affect its Australian reported earnings.
South 32 Global Presence
Map above shows the footprint of South 32. It is called S32 because it operate around the 32 parallel.
Highlight from the map above is the exposure to South Africa which does not have a great reputation for business and weak domestic outlook.
South 32 Commodity Production Volume
We are conscious that absolute production numbers can get out dated very quickly. Table above shows the current production volume at the time of the demerger. Bar mergers and acquisitions, future expansion plans and changes in business operations. The profile and relative volumes should broadly trend going forward.
South 32 EBIT by commodity
Some highlights from first glance:
Alumina and Manganese are major commodity exposures for South 32. Management has stated that first step post demerger is to take cost out of the business.
Given the weak coal price outlook, this is an area investors have to pay attention to. From an optimist point of view. The inherent operating leverage in the coal business means the upside will be there as prices recover.
This is offset by possibility of prolong weakness in China and structural challenges in energy consumption patterns shifting towards gas which is “cleaner”. We a leaning towards LNG with the likes of Origin and Woodside on this front.
Additionally metallurgical coal and manganese also face headwinds from weak global steel production.
South 32 Financial Statement (Summary)
The aspect of the company we like the most is the balance sheet. It provides a safety cushion to a volatile industry where there are number of uncertain factors that are critical to business performance.
Once the cost cut is done, then focus will be on growth. A strong balance sheet provides ample financial firepower to spend on growth either internally (preferred) and external (bolt on). Transformation deals with predators in the sector like Glencore or otherwise cannot be ruled out.
EBIT margin while not BHP iron ore division margins are decent however the operating leverage on any recovery in commodity prices will mean it will expand healthily, vice versa with any leg down in the core S32 commodities.
Other highlight from the summary financials the cash generation ability of the business. While EBIT which can be seen as a proxy for underlying cashflow is $800m, total cashflow is closer to $1.2billion. Taking into consideration the critical nature of capex spend for miners there is still significant potential free cash in the business to take out.
If global weakness persist, the balance sheet will ensure S32 will survive and come out of other side alive.
Given the take advantages of Australian investors which leads to preference for dividends. Alot of focus is on the dividend payout, we are more focused on the growth prospects. Any dividends will be good however we are sure there will be underlying assets that would have higher rate of return than the broader market. Capital expenditure cashflow need to kept an eye on to make sure the business is not starved of capital.
Capital Expenditure – Historical Context
With any miner, the capital expenditure is the bread and butter of the business. Management provided the historical financials and we can certainly see the peak spend during the boom. This has come off and interesting to see where it settles.
South 32 Outlook
If the commodity down cycle bottom here then this is the best time to get in to S32 to gain exposure to these commodities. We are just unsure that we have seen all the weakness flushed out from the global economy.
Solid balance sheet and management experience is a certain plus however there will be alot of disruption from demerger, the post demerger changes and it will take time for the dust to settle and the business to march to the beat of its own drum.
Will keep an eye on this.