Company Reports

Commodity prices diverged in the quarter. Despite solid China steel production, iron ore and metallurgical coal prices are down, while copper rose on supply issues and hopes of faster global growth. However, prices are elevated compared with history and cost-curve support.

Iron ore prices are lower on concerns over China steel demand due to its struggling property market and weak infrastructure spending. However, gold prices are up on optimism over peak interest rates, driving a 2% rise in our estimate for no-moat Newmont, to USD 51. It remains the cheapest miner we cover, trading 27% below fair value.

Demand growth from China has been the main driver of rising commodity prices in the past two decades. More recently, though, most commodity prices have fallen from highs set with Russia’s invasion of Ukraine, the subsequent sanctions on Russia, and the rerouting of supply chains. Prices, nevertheless, are generally elevated versus the 20-year average, as well as relative to cost support.

We modestly reduced our fair value estimate for no-moat South32 by 3% to AUD 3.50 per share after the company agreed to sell its Illawarra metallurgical coal business. Likely effective first half fiscal 2025, total sales proceeds are up to USD 1.65 billion in cash. USD 1.05 billion is receivable upfront. Additional deferred consideration of USD 250 million is receivable in 2030 and contingent consideration of up to USD 350 million, depending on metallurgical coal prices over the five years after the deal closes. Roughly USD 250 million in rehabilitation and other liabilities are also transferable to the purchaser. We think this is a modestly better deal for the purchaser than South32. We dislike the lengthy time before the deferred consideration is receivable, and under our current metallurgical coal price assumptions, only approximately half of the deferred consideration will be paid.

South32 is a diversified midtier global mining company spun out from BHP in 2015. South32 has commodity diversification and its operations are generally in the bottom half of their industry cost curves. However, they generally lack maintainable competitive advantage given relatively high capital intensity, a lack of barriers to entry, and in some cases, relatively short reserve life.

South32 is a diversified midtier global mining company spun out from BHP in 2015. South32 has commodity diversification and its operations are generally in the bottom half of their industry cost curves. However, they generally lack maintainable competitive advantage given relatively high capital intensity, a lack of barriers to entry, and in some cases, relatively short reserve life.

No-moat South32’s first-half fiscal 2024 result was materially weaker than we expected. Adjusted net profit after tax of USD 40 million—USD 0.9 cents or AUD 1.4 cents per share—is down 93% on last year. Adjusted EBITDA roughly halved to about USD 710 million, driven by lower aluminum, nickel, and manganese prices and metallurgical coal sales volumes. While net debt of about USD 1.1 billion more than doubled in the half, at 0.6 times trailing 12 months EBITDA, it is manageable, and the balance sheet is sound. Around 75% of the increase reflected unfavorable working capital moves, mostly temporary, and the fiscal 2023 final dividend and first-half share repurchases. The company has canceled its buybacks to maximize its balance sheet flexibility given lower near-term commodity prices, which we think is sensible despite the shares being materially undervalued. While the USD 0.4 cent, about AUD 0.6 cents per share, fully franked interim dividend reflects materially lower earnings.

Near-term iron ore prices are higher on strong China steel production. Gold prices are up on optimism over peak interest rates, driving a 2% rise in our estimate for no-moat Newmont, to USD 54. It is the cheapest we cover, trading 30% below fair value.

South32 is a diversified midtier global mining company spun out from BHP in 2015. South32 has commodity diversification and its operations are generally in the bottom half of their industry cost curves. However, they generally lack maintainable competitive advantage given relatively high capital intensity, a lack of barriers to entry, and in some cases, relatively short reserve life.

Commodity prices diverged in the quarter with strong China steel production driving iron ore and metallurgical coal prices up, while base metals prices dropped on worries of a Western recession. Even so, prices are elevated versus history and cost-curve support.

Strong China steel production is supporting prices for steel inputs despite recession concerns. Otherwise, changes to our commodity price assumptions are mixed, led by higher near-term iron ore prices and lower near-term thermal coal prices. We think thermal coal miner Whitehaven Coal and minerals sands miner Iluka are the cheapest we cover. Both trade at 29% discounts to our AUD 9.50 and AUD 10.50 per share fair value estimates, respectively, with Whitehaven’s down 3% on lower near-term thermal coal prices, partially offset by a weaker Australian dollar. Peer New Hope is also down 3% to AUD 6.10 per share. Iluka’s estimate is unchanged, with a weaker Australian dollar offsetting lower synthetic rutile prices.

South32 is a diversified midtier global mining company spun out from BHP in 2015. South32 has commodity diversification and its operations are generally in the bottom half of their industry cost curves. However, they generally lack maintainable competitive advantage given relatively high capital intensity, a lack of barriers to entry, and in some cases, relatively short reserve life.

Commodity prices have generally stabilized after falling on concerns that China’s reopening would underwhelm, along with worries over a recession in the West. Even so, they remain elevated versus history and cost-curve support. The Russian invasion of Ukraine and subsequent sanctions on Russia support energy prices and reinforce the importance of energy security.

No-moat South32’s 2023 result was weaker than our expectations. Adjusted net profit after tax was USD 920 million, or around AUD 0.20 per share, down from USD 2.6 billion last year. Adjusted EBITDA also fell 47% to about USD 2.5 billion, on lower prices and sales volumes. Otherwise, higher costs were offset by favorable foreign exchange movements. The USD 3.2 cent (about AUD 4.9 cents) per share fully franked interim dividend was 82% below last year on lower earnings but was consistent with the minimum 40% payout ratio. It also modestly increased its remaining share buyback by USD 50 million to USD 130 million, the small amount immaterial to our fair value estimate. South32’s balance sheet is strong, with a modest net debt of about USD 480 million, 0.2 net debt/EBITDA.

No-moat South32’s fiscal 2022 result was impressive, driven by higher commodity prices and a higher AUD/USD rate, which more than offset increased cash operating costs. Adjusted net profit after tax was USD 2.6 billion, or USD 0.56—around AUD 0.81—per share, up more than five times on the prior year. Adjusted EBITDA increased about 160% to USD 4.8 billion, driven by metallurgical coal, alumina, and aluminium. Accounting for two thirds of EBITDA in fiscal 2022, average realised prices for these commodities rose around 230%, 50%, and 40% respectively, on similar sales volumes to fiscal 2021. Compared with our expectations, metallurgical coal and aluminium were the standouts with unit costs not rising as quickly as we thought and the realised coal price exceeding our forecast.

Commodity prices have generally fallen over the second quarter of 2022 as central banks try to regain control of inflation, raising interest rates faster than many investors expected. This has led to fears of recession and lower demand for many commodities, with China’s attempts to contain COVID-19 also a drag. After updating our commodity price assumptions, the fair value estimates for most miners on our coverage fall. We think gold miner Newcrest remains cheapest, trading at around a 40% discount to our unchanged fair value of AUD 33 per share.

The outbreak of war in Ukraine, and the subsequent sanctions levied on Russia, has sent shockwaves through commodity markets. As we saw with Vale’s tailings dam failure in 2019, supply shocks can materially affect the outlook for prices and valuations. But the impact of supply shocks is not always intuitive. There’s one major difference between the current largely sanctions-driven supply disruptions and Vale’s tragedy. The supply capacity being disrupted is still intact in Russia. An outbreak of peace and a political agreement could see Russian commodity supplies return to the global market relatively quickly. Given that, there is considerable uncertainty as to how long any potential supply disruption will last.

Production for no-moat South32 was a mixed bag in the second quarter of fiscal 2022. Full-year guidance for manganese ore production was cut and metallurgical coal output appears to be tracking below our prior expectations and guidance. On the plus side, mining volumes and grades at Cannington have performed better than expected and South32 has increased guidance. Overall, we’ve cut our expectations for Australian manganese ore sales by 9% and coking coal by 5%, while increasing Cannington volumes by about 4%. As a result, we’ve lowered our full-year net profit after tax forecast by 11% to USD 1.6 billion or USD 0.36 per share.

No-moat rated South32 delivered a solid fiscal 2021 result, with adjusted net profit after tax up about 150% to USD 489 million. Adjusted EBIT nearly doubled to USD 844 million from USD 446 million, thanks to higher commodity prices, and was in line with our expectations. The company did a creditable job at offsetting inflationary pressures, primarily through cost reductions and efficiencies.

We still see general overvaluation among our listed mining coverage with the average price/fair value estimate sitting at a 9% premium, versus 10% in April. But some of the recent commodity price moves are yet to be factored into the share prices and we rate seven stocks as undervalued. Thermal coal miners New Hope and Whitehaven remain the cheapest of our coverage. Along with Glencore and South32, the firms trade in 4-star territory. Alumina Limited, Newcrest, and Teck Resources are also at modest fair value discounts.