South32: Multiple Levers To Unlock Value (OTCMKTS:SOUHY)

Elevator Pitch

I keep my Buy investment rating for South32 Limited’s (OTCPK:SOUHY) [S32:AU] shares unchanged.

I wrote specifically about South32’s capital allocation approach in my earlier September 19, 2022 update for the company. The focus of my latest article is South32’s near-term outlook.

There aren’t any major negative surprises relating to the company’s recent quarterly operating data release. Moving ahead, South32 is in a position to engage in actions that could unlock the value of the company’s shares like buybacks and asset sales. Moreover, South32’s valuation multiples could witness a positive re-rating in the short term, thanks to tailwinds for commodities driven by China’s reopening. Taking into account these factors, I make no changes to my existing Buy rating for the stock.

South32’s shares are traded on both the Over-the-Counter market and the Australian Securities Exchange. According to S&P Capital IQ data, the three-month average daily trading value of South32’s OTC shares was decent at above $1 million. In comparison, the daily trading value for South32’s Australia-listed shares in the past three months was even higher at over $60 million. Readers who demand much better trading liquidity can choose to trade in South32’s shares listed in Australia relying on brokers with international market access like Interactive Brokers.

Positive Takeaways From Recent Quarterly Metrics

South32 reports the company’s financial performance on a semi-annual basis, and it is expected to announce its earnings for the first half of fiscal 2023 (YE June 30) sometime in mid-February next year.

But the company does release production data on a quarterly basis, which offers clues about its 1H FY 2023 results (July 1, 2022 to December 2022 period in calendar year terms). Note that the third quarter of calendar year 2022 is equivalent to the first quarter of South32’s fiscal 2023.

The most recent Q3 2022 (calendar year) production report released by South32 was encouraging. Apart from the lowering of its fiscal 2023 copper equivalent production growth guidance slightly from +14% to +13%, South32 retained the company’s FY 2023 production guidance for the other commodities within its portfolio.

Specifically, South32 witnessed a +6% QoQ increase in manganese ore production volume at its GEMCO mine from 844 kwmt (thousand wet metric tons) for Q4 FY 2022 to 898 kwmt in Q1 FY 2023. Separately, even though South32 reduced its FY 2023 guidance relating to copper production, the company also achieved a robust +12% QoQ increase in total payable copper production in the first quarter of the current fiscal year. These were the two key quarterly operating metrics for South32.

I previously touched on South32’s pivot away from coal mines towards “base metals projects” which will make the stock “more appealing to investors with a strong emphasis on Environmental, Social and Corporate Governance or ESG issues” in my prior September 19, 2022 write-up for the company. At its earlier annual shareholders’ meeting in late-October, South32 guided that the company’s portfolio exposure relating to base metals is expected to increase further from 75% now to 85% in the short-to-medium term.

South32’s reasonably strong manganese and copper volume growth in the most recent quarter suggest that the company remains on track to reposition its portfolio for a new low-carbon future.

Potential Value Unlocking Initiatives

There are a number of levers that South32 can rely on to boost shareholder value, which are detailed below.

In my September 2022 article, I discussed about how South32 can create value by accelerating its pace of share repurchases, taking into account the low EV/EBITDA valuations for its stock.

Separately, South32 disclosed in its recent production report (which I made reference to in the preceding section) that it earned $200 million in the first quarter of fiscal 2023 by monetizing “four non-core base metal royalties.”

Looking forward, the potential divestment of South32’s Illawarra metallurgical coal mine in Australia is on the cards. One key factor is that the company’s current strategy is to increase exposure to base metal projects and reduce exposure to coal mines.

Another key factor is that the Illawarra metallurgical coal mine isn’t performing well, which makes it less painful for the company to part ways with this particular asset. As highlighted in its recent production report, South32 saw its coal production volume for the Illawarra metallurgical coal mine decrease by -16% YoY in Q1 FY 2023.

China’s Reopening Will Be A Boost For Commodity Prices

It is reasonable to assume that South32’s share price is positively correlated with the increase in commodity prices.

Notably, China is gradually pivoting away from its COVID-zero policy. A December 5, 2022 Reuters news article reported that “China is set to announce a further easing of some of the world’s toughest COVID curbs.”

China is recognized by Bloomberg as “the world’s largest consumer of commodities”, so there is no surprise that China’s reopening (and resulting increase in demand for commodities) will be a tailwind for commodity prices and mining companies like South32.

Concluding Thoughts

South32’s shares continue to warrant a Buy rating in my opinion. The stock could benefit from catalysts like a faster pace of share repurchases or asset divestments, while China’s reopening might help to re-rate the valuations of mining sector as a whole.