Why South32 is high on cash

A re­cent re­port from the Aus­tralian bank Mac­quarie high­lights South32’s abil­ity to ab­sorb planned cap­i­tal ex­pen­di­ture as the company is ex­pected to gen­er­ate $1bn in free cash flow per year be­tween 2020 and 2030.

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south32 has es­tab­lished it­self in the global di­ver­si­fied min­ing re­sources mar­ket as a stock high on in­vestor re­turns and low on risky merger and ac­qui­si­tion ac­tiv­ity. The firm’s sur­pris­ing $1.3bn cash of­fer for a Toronto-listed company, Ari­zona Min­ing, ear­lier this year was seen as some­thing of a once-in-a-life­time ex­cep­tion to the rule, but it nonethe­less led some an­a­lysts to de­clare high-growth sea­son for all min­ing stocks for­mally open.

A re­cent re­port from

Mac­quarie, the Aus­tralian bank, how­ever, seems to sup­port the idea that South32’s CEO,

Gra­ham Kerr, is be­com­ing more com­fort­able with South32 as a growth stock, es­pe­cially given the bal­ance sheet and man­age­ment ca­pac­ity that is be­ing cre­ated in the Perth-head­quar­tered group.

Ac­cord­ing to the bank, af­ter hav­ing met Kerr in a roundtable meet­ing last month, the $850m cap­i­tal ex­pen­di­ture re­quired to de­velop Ari­zona Min­ing’s key un­de­vel­oped Her­mosa prospect – pri­mar­ily a zinc de­posit – can be eas­ily ab­sorbed as South32 is ex­pected to gen­er­ate $1bn a year in free cash flow be­tween the

2020 and 2023 fi­nan­cial years.

“South32 con­firmed that the company con­tin­ues to have both ex­cess bal­ance sheet and man­age­ment ca­pac­ity to pur­sue fur­ther ac­qui­si­tions,” said the bank’s an­a­lysts in a note dated 29 Au­gust.

“CEO Gra­ham Kerr high­lighted sim­i­lar­i­ties be­tween Her­mosa and Can­ning­ton [South32’s zinc fa­cil­i­ties in Aus­tralia] and the abil­ity to draw on in­ter­nal per­son­nel as Can­ning­ton ap­proaches end-of-life at a broadly sim­i­lar point in time as pro­duc­tion from Her­mosa be­gins to ramp up,” the an­a­lysts added.

The strength of South32’s cash gen­er­a­tion even sur­prised Gold­man Sachs. The net cash bal­ance at the full-year point ended 30 June, be­fore hav­ing paid for the Ari­zona ac­qui­si­tion, was about $2bn. Gold­man Sachs said this was “… higher than our fore­cast of $1.8bn, demon­strat­ing strong cash gen­er­a­tion in the sec­ond half of the year”.

The firm’s bal­ance sheet will soon enough be sup­ported by the pro­ceeds from the sale of its South African En­ergy Coal (SAEC), which it said at its an­nual re­sults pre­sen­ta­tion was now pro­ceed­ing. Some 40 un­so­licited and un­qual­i­fied bids had been re­ceived to date. It makes sense to make the sale if only be­cause the coal ex­port mar­ket is look­ing de­cid­edly juicy, with prices well in ex­cess of $100/t. SAEC gen­er­ated $353m in un­der­ly­ing pre­tax earn­ings for the 2018 fi­nan­cial year, equal to about 14% of the group’s to­tal.

While hardly neg­li­gi­ble, SAEC is not qual­i­fied to sell new sources of coal to Eskom in terms of its cur­rent own­er­ship model. There is also a hefty $739m re­ha­bil­i­ta­tion pro­vi­sion on the coal mines.

The mines are also highly cap­i­tal in­ten­sive while its Mid­del­burg Wolvekrans Com­plex (MWC) has a do­mes­tic con­tract with Eskom from which it strug­gles to make money. It has been ob­served that a black-owned sup­plier of MWC coal to Eskom could prob­a­bly ne­go­ti­ate a bet­ter con­tract given the util­ity’s in­ter­est in sup­port­ing black-owned busi­nesses go­ing for­ward.

Speak­ing to fin­week ear­lier in the year, Kerr said that de­spite with­draw­ing from South Africa, the company hadn’t com­pletely given up on pur­su­ing new in­vest­ment in the coun­try pro­vided it could se­cure some type of reg­u­la­tory cer­tainty in the fu­ture – a ref­er­ence to the Min­ing Char­ter ne­go­ti­a­tions un­der­way.

The company also has man­ganese op­er­a­tions in joint ven­ture with An­glo Amer­i­can in the North­ern Cape, so South32 is still a pres­ence on the ground in SA, as well as a listed en­tity on the JSE.

Kerr said that Africa re­mained a po­ten­tial hunt­ing ground for ac­qui­si­tions. The company op­er­ates the Mozal alu­minium smelt­ing fa­cil­i­ties in Mozam­bique, a coun­try where it has some com­fort op­er­at­ing.

Said Kerr: “Tanzania is also in­ter­est­ing, but places like the Demo­cratic Repub­lic of Congo are not for us. Too risky now that with the di­vest­ment of Freeport there is a di­min­ished Amer­i­can pres­ence.” ■ ed­i­to­rial@fin­week.co.za CEO of South32 While com­pa­nies like South32 have cash to burn, the same couldn’t be said of Har­mony Gold – an or­gan­i­sa­tion in a whole dif­fer­ent uni­verse in terms of liq­uid­ity. An­a­lysts think it may have to turn to eq­uity in or­der to fi­nance its next ma­jor tran­si­tion.

From its be­gin­nings in the 1990s, Har­mony Gold built a strat­egy on buy­ing mines other firms couldn’t man­age prof­itably. With a low-cost, in­no­va­tive ap­proach to min­ing ‘the old’, it flour­ished for years. At one stage, it was among the largest gold pro­duc­ers glob­ally.

How­ever, there were only so many tired old mines avail­able in SA for the Har­mony treat­ment. Now it’s do­ing what it has never achieved – or at­tempted – be­fore: build­ing a mine from scratch in the form of its Pa­pua New Guinea prospect, Golpu – an enor­mous ore­body of gold and cop­per it shares with joint ven­ture part­ner Newcrest Min­ing. It will cost more than $1bn to build and many years to re­alise a re­turn, the fear be­ing that Har­mony has a deficit in both time and cap­i­tal given the largely ex­hausted gold re­sources avail­able to it in SA.

It re­cently bought Moab Khot­song for $300m from An­gloGold Ashanti and brought its Hid­den Val­ley mine out of moth­balls – tak­ing pro­duc­tion up to 1.5m ounces a year, more than it has pro­duced in years. But an­a­lysts think it can’t con­tinue for long at this pro­duc­tion level, rais­ing ques­tions over the firm’s abil­ity to gen­er­ate the cash flow that can help po­si­tion it to see Golpu through to pro­duc­tion.

“While we al­ways viewed fund­ing Golpu as a con­cern for Har­mony, now with the ad­di­tion of Moab and Hid­den Val­ley reach­ing com­mer­cial lev­els of pro­duc­tion … we fore­cast Har­mony to gen­er­ate R4.2bn in free cash flow,” said Mac­quarie’s Yatish Chowthee in a re­cent re­port. “With Golpu’s project capex pegged at R20bn, the R4bn gen­er­ated falls sig­nif­i­cantly short as a start­ing point. Har­mony would have to come to the eq­uity mar­ket to raise cap­i­tal,” said Chowthee.

An­other op­tion – out­side of heavy debt – is that Har­mony’s 13% share­holder, African Rain­bow Min­er­als, be­comes a sig­nif­i­cant share­holder in the project, or at the top level by un­der­writ­ing or di­rectly par­tic­i­pat­ing in an eq­uity is­sue. Only then, us­ing the heft of a company that has the ben­e­fit of di­ver­si­fi­ca­tion, could Har­mony hope to sur­vive in the long term. ■

South32 hadn’t com­pletely given up on pur­su­ing new in­vest­ment in South Africa.

Gra­ham Kerr

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