Investing in natural resources companies can be a maddening pursuit. Google a major commodity and on any given day the search engine's prognoses will span the resurrection and death of both supply and demand. Identifying the winners among the diversified miners, in particular, can feel like a spin of the fruit machine, in the hope that Chinese industrial policy, dollar strength and South African labour relations will all line up for the payout. But the investing lesson of 2016 is that it pays to at least have some exposure to miners. Even if it does not repeat last year's 200 per cent gains anytime soon, we think the current price of shares in South32 (S32) represents a good entry point for long-term holders. That's because what the Australian group lacks in its mining portfolio, it makes up for in balance sheet strength, cash flows and patient strategic thinking.
- Growing cash pile
- Decent dividend prospects
- Nickel exposure
- Dollar earning
- Coal pricing pressure
- Commodity volatility
South32's origins were forged in the nadir of the commodities cycle. Since it was spun out of BHP Billiton (BLT) in 2015, the board's mindset has been trained on cash generation and sensible planning. The company began life with net debt of $674m (£542m) but by the end of June, analysts at HSBC expect the group to have swung to a net cash position of $1.88bn.
Getting there has involved a keen focus on cost management and cash generation: free cash flow bucked the industry trend when it hit $634m in the 12 months to June. This year, a huge surge in the metallurgical coal price, as well as a resurgence in alumina and aluminium prices, has put the group on course for $1.3bn of free cash flow based on Bloomberg's consensus forecasts, falling slightly to $1.2bn in 2018.
That should greatly support South32's commitment to return 40 per cent of underlying earnings to shareholders, a far more sensible policy than the come-what-may progressive dividends which larger peers BHP and Rio Tinto (RIO) had to abandon a year ago in the pit of the commodities cycle. And South32's 2.5 times dividend cover leaves plenty of room to recycle earnings into new projects, such as the $200m acquisition of Peabody's Metropolitan Colliery and Port Kembla terminal in the final months of 2016.
What the group lacks is core exposure to base metals such as copper and iron ore, or even the highest-grade assets in its key commodities. But its nickel and zinc assets are excellently positioned for further contractions in those metals' markets; ditto South32's 19m ounces of silver production expected this year. Admittedly, these will need to compensate for lower earnings from its manganese mines in South Africa and Australia, and an uncertain coal market, but management sounds chaste when it comes to buying assets.
SOUTH32 (S32) | ||||
|---|---|---|---|---|
| ORD PRICE: | 155p | MARKET VALUE: | £8.27bn | |
| TOUCH: | 155-156p | 12-MONTH HIGH: | 181p | LOW: 41p |
| FORWARD DIVIDEND YIELD: | 3.5% | FORWARD PE RATIO: | 11 | |
| NET ASSET VALUE: | 177¢ | NET CASH: | $295m | |
| Year to 30 Jun | Turnover ($bn) | Pre-tax profit ($bn)* | Earnings per share (¢)* | Dividend per share (¢) |
|---|---|---|---|---|
| 2014 | 8.34 | 0.13 | 1.20 | nil |
| 2015 | 7.74 | 0.46 | 0.50 | nil |
| 2016 | 5.81 | 0.25 | 3.0 | 1.0 |
| 2017* | 6.88 | 1.65 | 20.0 | 8.2 |
| 2018* | 6.65 | 1.36 | 17.0 | 6.7 |
| % change | -3 | -18 | -15 | -18 |
Normal market size: 10,000 Matched bargain trading Beta: na £1=$1.23 *HSBC forecasts, adjusted PTP and EPS figures | ||||
