3Q18; a little disappointing except for those commodity prices
South32’s operations threw-up a real dogs’ breakfast of a March quarter with some records made, but overall operations were generally on the softer side for the quarter. Guidance for 2018 remained mostly unchanged however, but with a slight bias toward upgrades. The standout for the quarter, on the company’s rhetoric and our antipodal evidence, was commodity prices. The following table is a summary of the company’s operational performance for the March quarter 2018:
Source: South32 (ASX:S32)
Overall, we consider the operational results for March were somewhat disappointing, reflecting operating events that delivered a tough environment and a sloppy result. We take some comfort in that 2018 guidance for the majority of the company’s product offerings remained unchanged.
The standout product offering for the March quarter was manganese, following the reporting of a 32% rise in production compared to the March quarter 2017, to 62,000 tonnes. The following chart shows quarterly production for manganese ore (left chart) and alloys (right chart):
Source: South32 (ASX:S32)
The extraction of manganese ore rose by 6.5% compared to the March quarter 2017, to 1.4 million wet tonnes. Manganese alloy production surged ahead by 32% over the same comparative period as ore, to 62,000 tonnes.
The company’s manganese operations are located in Australia (South32’s interest 60%) and South Africa (South32’s interest 60%). Driving the better March quarter result was the Australian operations for both ore and alloy. Manganese ore extraction rose by 15% compared to the same quarter in 2017, to 830,000 wet tonnes. Manganese alloy production surged by 46% over the same comparative period as ore, to 41,000 tonnes. The Australian operations reported improved efficiencies with sections of the circuit operating in excess of capacity.
Australian manganese ore extraction guidance for 2018 was upgraded on the back of the March quarter results, to 3.3 million wet tonnes.
The previous guidance was for 3.125 million wet tonnes. In 2017, the company extracted 3.0 million wet tonnes.
The South African manganese operations delivered a lower manganese ore extraction number, but higher manganese alloy production for the March quarter. Ore extraction fell by 4.8% compared to the March quarter 2017, to 539,000 wet tonnes. Manganese alloy production on the other hand rose by 10.5% over the same comparative period as ore, to 21,000 tonnes. Extractions were impacted negatively by infrastructure availability, with alloys positively impacted by grades and recoveries.
Guidance for South African manganese ore extraction in 2018 was upgraded to 2.15 million wet tonnes, from the previous forecast of 2.04 million wet tonnes. In 2017, the company extracted 2.0 million wet tonnes.
Zinc production for the March quarter printed a fall of 43% compared to the same quarter in 2017, to 15,100 tonnes. The following chart shows quarterly zinc production:
Source: South32 (ASX:S32)
Driving the lower zinc result were events at the company’s Cannington mine (sole producer of zinc) where operations transitioned to a replacement underground crusher and mine sequencing delivered lower grade ore. Ore mined at Cannington fell by 15% on the March quarter 2017, to 571,000 tonnes. The zinc grade dropped to 5.2% for the reported quarter from 5.3% a year earlier.
Guidance for zinc production in 2018 remained unchanged at 39,000 tonnes.
The sequencing of low grade ore at Cannington will continue over the remainder of 2018. In 2017, the company produced 70,400 tonnes of zinc.
Alumina also turned in a softer operational performance for the March quarter following the printing of a 4.3% fall on the third quarter 2017, to 1.2 million tonnes. The following chart shows quarterly alumina production:
Source: South32 (ASX:S32)
The softer performance was driven primarily by the results of the Worsley (South32’s interest 86%) operation. The Worsley refinery reported a fall of 4.7% compared to the third quarter 2017, to 918,000 tonnes of alumina. Unplanned infrastructure availability drove the result. Alumina production out of Brazil (S32’s interest 36%) also came in lower, falling by 3.1% compared to the March quarter 2017, to 314,000 tonnes. Unplanned maintenance drove the result.
Alumina production guidance for 2018 remained unchanged at 5.3 million tonnes.
Contributions by the individual refineries to the target are forecast at 4.0 million tonnes for Worsley and 1.3 million tonnes for Brazil.
Downstream from alumina is the company’s aluminium operations, which printed a modest fall of 1.2% compared to the March quarter 2017, to 242,000 tonnes. The following chart shows quarterly aluminium production:
Source: South32 (ASX:S32)
In aluminium, South Africa was the primary driver, following the printing of a 1.6% fall compared to the March quarter 2017, to 175,000 tonnes. An unplanned incident that shut-in production, drove the result. Post the event all pots are returning to normal production. Mozal (S32’s interest 47.1%), the company’s other aluminium site, reported flat numbers compared to the March quarter 2017 at 67,000 tonnes. To the nine-months to 31 March the Mozal smelter is running at a record capacity of 204,000 tonnes and is now testing its maximum capacity.
Guidance for 2018 on the aluminium front remained unchanged at 269,000 tonnes.
In 2017, the company produced 271,000 tonnes of aluminium.
The company produces both metallurgical (met) and energy coal, with met coal being the only dark spot in the company’s March quarter result. First to energy coal which reported a 3.5% rise compared to the same quarter in 2017, to 7.1 million tonnes. The following chart shows quarterly energy coal production:
Source: South32 (ASX:S32)
South Africa is the company’s main energy coal producer, and it reported a 1.0% rise when compared to the March quarter 2017, to 6,741 tonnes. Energy coal destined for the domestic market in South Africa fell by 5.4% when compared to the March quarter 2017, to 3.8 million tonnes, on softer third party demand. Finally, export energy coal reported a surge of 21% compared to the March quarter 2017, to 3.5 million tonnes. Driving the export result was the company’s Wolvekrans-Middelburg Complex, which benefitted from ongoing investment.
A small quantity of energy coal is produced in Australia at the company’s Illawarra site. Production surged by 94% compared to the corresponding quarter in 2017, to 355,000 tonnes. The 2017 number was impacted by unexpected outages.
Overall, South African energy coal guidance for 2018 remained unchanged at a total of 27.5 million tonnes.
The company is targeting 16 million tonnes on domestic energy coal going into South Africa and 11.5 million going out as export coal. Guidance for Australian energy coal remained unchanged at 1.15 million tonnes. In 2017 the company produced 28.9 million tonnes of energy coal.
Illawarra met coal production was lower for the March quarter, following the reporting of a 45% fall compared to the March quarter 2017, to 794,000 tonnes. The following chart shows quarterly met coal production:
Source: South32 (ASX:S32)
An extended outage at the Appin colliery was behind the poor result. The outages included two longwall moves and a focus on coal clearance and rehabilitation activities.
As a result of the March quarter outcome for the Illawarra met coal operations, 2018 guidance was downgraded to 2.95 million tonnes, from the previous forecast of 3.35 million tonnes. In 2017, the company produced 5.7 million tonnes of met coal.
On the corporate front, the company reported a net cash amount of US$1.9 billion, compared to US$1.5 billion at 31 March 2017. The company did not provide details on debt at 31 March 2017. However, greater clarity around the financials will be provided when it reports its 2018 full year result during August 2018. We have no concerns with the company’s liquidity position on the brief provided.
We believe the company’s assets certainly have the capabilities to generate future shareholder value. With the requisite long-life and quality we look for, while also positioned in the competitive part of the appropriate cost curves; all are key investment metrics.
We believe the total value proposition improves, as the company has a robust balance sheet, positive cash flow profile and experienced resource team.
Consequently, we continue to recommend South32 (ASX:S32) as a high conviction buy for Members with no exposure to the stock.
Disclosure: South32 (ASX:S32) is held within the Fat Prophets Mining and Resources, Concentrated Australian Share and Concentrated UK Share portfolios.
