S32 tipped to spring surprise payout

[miningmx.com] – THE secondary listing of South32 on the JSE has shed rare light on the troubled mining sector which has lost so many investors in the last 18 months that only three mining firms take their place among the top 20 shares.

Make that four; well, nearly. At a market capitalisation of about R106bn, South32 is the 21st largest stock on the bourse, but it is most likely to move higher based on the assessments of analysts who think the company is worth buying.

“We love the idea of South32 and see this as a great opportunity for its management to prove the unrealised value in these non-core assets,’ purred SP Angel, a UK stockbrokerage on the day of the firm’s listing.

South32 is the creation of BHP Billiton which decided to demerge its non-core assets – including coal, manganese and aluminium in South Africa; and nickel and coal in Australia – rather than sell them piecemeal in trade sales.

The theory is that it was better to let the market set the price for the assets rather than individual buyers busting for a bargain.

Apart from the logic of the demerger, South32 is also part of BHP Billiton’s strategy to reward its shareholders: each shareholder in BHP received one South32 share for every BHP share owned.

The company was initially meant to trade in Perth and Johannesburg only, but UK shareholders also asked for an opportunity to trade the share, hence its listing there.

Whether BHP Billiton will continue on the JSE indefinitely is a moot point, but for the time being there’s a lot to look forward to in South32, according to analysts.

The dividend policy is a minimum payout of 40% of earnings, but Macquarie Research thinks that could be much higher in the first year whilst Graham Kerr, South32’s CEO, sets about cost-cutting.

“We believe returns to shareholders could be closer to 70% in the first year as S32 rewards investors for patience while the cost-out program is implemented,’ said Kieran Daly, an analyst for Macquarie.

Cost savings have been calculated at about $300m and there will be further optimisation as the firm executives its regional approach to management.

“The regional model is an opportunity to get more out of existing assets,’ said Kerr. “We will take out some of the complexity of the assets and levels of management and increase their value,’ he said.

Asked by Miningmx if this was perhaps another way of saying retrenchments, Kerr responded: “No doubt South32 has some legacy issues from BHP. No doubt we will run the assets differently from day one and in how we structurally set ourselves up. We will look to be an organisation that is more lean, agile and entrepreneurial’.

There are, however, some things worth thinking about in respect of South32. One is its approach to the South African business environment.

In BHP Billiton’s hands, its coal assets struggled to compete for expansion or growth capital such that Khutala and Klipspruit – important suppliers to Eskom – have less than six years of operating life at current rates of production.

That means decisions on investing in them will have to be made soon, but how likely is that in the current environment where relations between the sector and the South African government have plumbed new depths, and the reach and meaning of empowerment is hard to decipher?

“At South32, we believe in what Government is trying to do. We are absolutely behind that in every single way,’ said Kerr. “Clearly, though, if we are going to invest large capital, we need certainty around policy.’

Said Kerr: “Klipspruit and Khutala and going along neck and neck on which is going to get an extension approval first. It will be the FY17 to FY18 before we have to make decision on the process. But those are the assets we are focusing on now’.

It’s also worth noting that South32’s coal assets are potentially a big headache for little return.

According to Standard Bank Group Equities, the 30.4 million tonne/year mines are the smallest slice of the pie contributing only $325m to net present value out of a total NPV of $12.7bn. (The report was written on March 17 before the mining market deteriorated further).

There’s also a requirement for South32 to establish its survival credentials: is it a hunter or the hunted?

Said Daly: “We do not expect S32 to look external in the first 12 months. However, should Anglo American look to sell its share of the manganese assets (held in joint venture with South32), then this could be the most logical first step’.

Set against this, is the nagging rumour that Mick Davis, CEO of X2, may bid for South32 which is well within his ability to fund assuming a slug of debt is added to his $5bn to $6bn cash pile.

“I can categorically say no, we have not been approached,’ said Kerr when asked by Miningmx if Mr Davis had been on the phone lately. “We will focus on the things we can control.’