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May 20, 2015
AUSTRALIA
ROCKS & STOCKS
Much ado about South32
Notes from the Field
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James Wilson
T +61 8 6160 8707
E [email protected]
Adrian Prendergast
T +61 3 9947 4134
E [email protected]
Tom Sartor
T +61 7 3334 4503
E [email protected]
South32 (ASX:S32) listed this week and as expected the stock is
experiencing a “washing out” period of volatility during its first week of
trading. The leverage to strong demand growth commodities such as
aluminium and nickel remain appealing but this suits investors with a
bullish medium-term view on base metals. We think the real prize is BHP,
its simpler structure, its diversified earnings stream and a strong leverage
to rebounding energy prices make it a standout in the sector.
Figure 1: South32 valuation breakdown
Chris Brown
T +61 7 3334 4885
E [email protected]
Call to action
Prefer BHP for energy exposure
BHP demerged its South32 assets this week.
As expected the volatility in the S32 share
price is playing out. Whilst we like the S32
story for a medium term base metals recovery,
we prefer BHP for its strong leverage to a
recovery in energy prices in the near term.
SOURCE: Morgans
The initial washing out period in South32 is happening now
Fundamental valuation aside, we argue that South32’s higher leverage (risk),
combined with the fall in commodity prices will generate a substantial “washing
out” period upon listing as un-natural holders (the risk averse, and mega-cap only
funds) are replaced by the natural holders (the risk tolerant, index huggers,
contrarians and M&A funds). What we’ve seen is a surprising uptick in the stock to
$2.36ps, still well below our valuation of $2.98ps (+30% upside to our target
price).
BHP is now much leaner and gets attractive below $30
Post de-merger we expect BHP will boast an enviable EBITDA margin across its
business of 47%, a forward PE ratio of 15x, a fully franked dividend yield of
~5.4% and valuation of A$33.90ps. We view these metrics as robust, with the
view that BHP will quickly start to fill the gap in its market capitalisation left by
the demerger. Furthermore, we see near-term leveraged upside in BHP’s energy
division, which represents about 31% of its valuation. The energy division is
likely to grow in proportion to the rest of BHP’s business supported by a
medium-term recovery in oil prices – it’s the sector to watch, in our view.
Prefer BHP for energy upside over S32 for base metals recovery
S32 offers an attractive suite of assets with strong leverage to upside in the nickel
and alumina divisions (49% of FY15 EBITDA earnings) but tempered by subdued
manganese prices (about 21% of FY15 EBITDA earnings) so ultimately we think a
bullish view on base metals is required to hold the stock longer term. Conversely we
have a high conviction view on BHP. The recent cost cutting in FY16 iron ore to
US$16/t (from US$20/t) and a cut in its FY16 oil and gas capex to US$1.5bn (from
US$4bn) have contributed to our price target of A$33.90ps (from $34.90ps),
which hasn’t changed a great deal despite the capital rebasing post the S32
de-merger.
IMPORTANT DISCLOSURES REGARDING COMPANIES THAT ARE THE SUBJECT OF THIS REPORT AND AN EXPLANATION OF RECOMMENDATIONS
CAN BE FOUND AT THE END OF THIS DOCUMENT. MORGANS FINANCIAL LIMITED (ABN 49 010 669 726) AFSL 235410 - A PARTICIPANT OF ASX GROUP
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MINING
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DISCLAIMER
The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual’s relevant
personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents
(“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this
report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser
before doing so. Those acting upon such information without advice do so entirely at their own risk.
This report was prepared as private communication to clients of Morgans and is not intended for public circulation, publication or for use by any third party. The contents of
this report may not be reproduced in whole or in part without the prior written consent of Morgans. While this report is based on information from sources which Morgans
believes are reliable, its accuracy and completeness cannot be guaranteed. Any opinions expressed reflect Morgans judgement at this date and are subject to change. Morgans is
under no obligation to provide revised assessments in the event of changed circumstances. This report does not constitute an offer or invitation to purchase any securities and
should not be relied upon in connection with any contract or commitment whatsoever.
DISCLOSURE OF INTEREST
Morgans may from time to time hold an interest in any security referred to in this report and may, as principal or agent, sell such interests. Morgans may previously have acted
as manager or co-manager of a public offering of any such securities. Morgans' affiliates may provide or have provided banking services or corporate finance to the companies
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REGULATORY DISCLOSURES
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