[miningmx.com] – AFTER a relatively strong debut on the Johannesburg Stock Exchange, South32 – born of the demerger of BHP Billiton’ non-core assets – has had something of a return to earth experience.
Shares in the company are a fifth lower compared to the debut price on May 18.
Analysts think some of the share slide is related to price adjustments in aluminium and alumina, two minerals to which South32 has exposure, which in turn will result in lower earnings and affect the size of the payout set by the company at 40% of earnings.
“We believe much of the weakness in these commodities has been factored in,’ said Macquarie Research in a report earlier this month.
“The cost out programme [cost reductions] … presents a material near-term catalyst for the stock and may go some way in offsetting some of the recent declines in South32’s key commodities,’ it added.
In an interview with Miningmx on July 6, South32 CEO, Graham Kerr, said commodity prices certainly had an effect on company’s share price. Sustained lower manganese prices, for instance, led to an announcement last month it was considering a write-down of its ferro-manganese assets in South Africa.
However, he has promised to lift productivity and reduce costs, although that’s easier said than done in South Africa – a difficulty Kerr acknowledges.
“It is a different equation in South Africa for the cost-out and productivity drives. There will be a reduction in headcount for the functional support in South Africa, but there’s no doubt that wage increases and the reliability and availability of power [lack of it] makes South Africa unique compared to other places that we operate in,’ he said.
“The cost per person in Australia is roughly as high as in South Africa, but the volume of people is less. So there are some headwinds that make it a bit more challenging in South Africa, but it’s not impossible,’ said Kerr.
In terms of South32’s South African assets, a lot of attention falls on its coal mines which are major suppliers to Eskom and were previously held in BHP Billiton Energy Coal South Africa.
The attention they attract – their relevance to Eskom’s increasingly desperate need for coal supplies as it seeks to keep the lights on – is disproportionate to their contribution, however.
As observed previously in Miningmx, the South African energy coal business only comprises 3% of net present value of South32’s assets either in terms of commodity mix or by asset. But Kerr believes the assets provide a foundation for growing South32’s involvement in South Africa.
“It’s easy to get caught up in the doom and gloom,’ he said. “Eskom is stretched from balance sheet point of view, and the cost of diesel [used in operating open cycle gas turbines] makes no economic sense.
“But our own projections with the two new power stations – Medupi and Kusile – is that Eskom is short on coal. From our perspective, there is an opportunity for us to build a sustainable and strong coal business in South Africa.
“Having said that, we need to make sure we have the right environment from regulatory point of view. We require Eskom and the government to create economically rational conditions in order to have a strong base to drive empowerment,’ said Kerr.
He is referring to the South African government’s demand that new suppliers of coal to Eskom ought to be 50% plus one share empowered – effectively cede control of the production.
“But we don’t get depressed,’ he said. “We think that is an opportunity and going forward we do believe that running a regional model and a lean operating model will help us drive the business harder.’
The outlook is somewhat different for the group’s nickel mine and ferronickel smelter at CMSA (Cerro Matosa) in Colombia and the bauxite and alumina facilities at the Alumar operations in Brazil.
As relatively standalone assets, they may not have the sufficient base to attract growth capital whilst Alumar is not operated by South32 which puts it at odds with the rest of the group’s mines.
“CMSA has running since early Seventies and is a relatively self-contained business,’ says Kerr. “Alumar is a joint venture where we are not the operators; we’re just an investor.
“Colobmia is a bit of an oddball. It’s fair to say that we need to decide whether we will build a bigger business in South America that will make it a third leg (to Australia and South Africa).
We have to decide what we want to keep in South America, but it’s too early to call right now.’
Kerr acknowledged the mining sector was a difficult place for investors owing to long-standing disappointment with the type of investments the industry has made in the past.
“It’s either been in the wrong asset, or at the wrong time, or both,’ he said.
According to Investec Securities, the major diversified mining sector is “going nowhere’ at present. Even though share prices in the likes of BHP Billiton and Glencore have value, there’s no apparent external stimulus that will excite future earnings.
“Ongoing commodity price volatility and our view of no significant recovery in prices until 2017 favour a cautious investment strategy,’ it said in a recent report.
What’s interesting in the report, however, is that it raises the possibility that a further deterioration in commodity prices could force the major miners to sell assets in order to maintain dividend payments.
The bank believes a lot of the “low hanging fruit’ in terms of cost reductions have been taken out of the system.
Might this create opportunities for Kerr and South32?
“We have a crawl, run, walk strategy. When we think about mergers and acquisitions, it’s not a strategy: it is opportunistic and we look at it when we see value for shareholders,’ he said.
“We want to establish predictable and reliable operations, maintain our investor grade credit rating, and then we have spoken about returning a miumum of 40% back to shareholders as part of payout ratio.
“Any cash that’s left has to compete against making further returns to shareholders either through a dividend or a buy-back of shares, or against projects we want to develop in the portfolio,’ he said.
