Is cash really king?
South32 has a strong balance sheet, but some question its acquisitions and share buyback scheme, writes Lisa Steyn
lobal diversified miner South32 is riding a cash high as commodity prices remain resilient and its operations perform well.
It’s taken the plunge on its first two acquisitions and is embarking on an extensive share buyback programme, but critics wonder if the company is making the best use of its stash.
South32 has its primary listing in Australia with secondary listings on the London and Johannesburg bourses.
At around R37 a share, it’s up almost 13% in the year to date and a considerable 125% in the past three years.
As seen in its results for the six months ended December 2018, the company is generating strong cash flows, and reported $718m in free cash flow from operations.
Jpmorgan analysts say in a note that while operationally South32 is now performing well, they regard the stock as fully valued.
Peter O’connor, metals and mining analyst at Australianbased Shaw & Partners, agrees and believes the share has been fully valued for some time.
This, he says, is because the prices of the commodities South32 deals in — manganese, metallurgical coal and alumina — are trading well above expectations.
GO’connor says the market is experiencing the tail-end of an 18-month uptick in commodity prices, with alumina prices already softer.
“South32 is not generating a level of earnings which I deem to be sustainable,” he adds.
The Jpmorgan analysts prefer BHP and Rio Tinto because of the iron ore exposure, capital management outlook, and relatively cheaper price-to-nav ratio — a key valuation metric for mining companies.
Since the Vale tailings dam disaster in Brazil in January, companies invested in iron ore, such as BHP and Rio Tinto, have traded at a discount, though they have recovered somewhat, says O’connor. ”They are cheaper than
South32 but not as cheap as they were,” he says.
South32 has had a strong balance sheet since it was spun out of BHP Billiton in 2015 and, seemingly keen to preserve this, has been slow to make acquisitions.
Last year it finally took the
gap and concluded two deals.
The first, announced in May, was its acquisition of a 50% interest in the Eagle Downs metallurgical coal project in Queensland, for an upfront cash payment of $106m and a further $27m, payable three years after the transaction. Then in June it announced the completion a $1.3bn acquisition of Arizona Mining.
At the time South32 indicated it was unlikely to go after any further merger & acquisition opportunities in the near future and would rather turn its full focus to its existing portfolio.
O’connor says that both are good assets and will contribute reasonable earnings, but neither was cheap because they were bought close to the top of the cycle and acquisition considerations were full.
“To me that’s a red flag,” he says. “I think they will prove value neutral at best and could potentially prove value negative.”
South32 has continued with a $750m share buyback programme which has been extended twice, and will now end in September.
The philosophy of Warren Buffett, considered one of the most successful investors of our time, is that while share buybacks can be good for investors, they should only be done when the price is less than the intrinsic value of the stock.
O’connor believe this is not the case for South32 and estimates the share is trading at 1.3 or 1.4 times to its fair value; that is, its net present value weighed against projected future cash flows.
“I think they are buying back shares at a premium,” he says. “I don’t think is the wisest
On the SA front, South32 is also seeking to renew its power supply deal for its Hillside aluminium smelter. The deal has been controversial