South32 reported FY18 underlying earnings of US$1.3bn, 4% above consensus estimates and 6% ahead of Ord Minnett’s forecast. The 13.5c dividend was in line with expectations, while net cash of US$2.04bn was higher than consensus at US$1.85bn and our forecast of US$1.89bn.
FY19 guidance for production was flat with the exception of Cerro Matoso and South Africa Energy Coal (SAEC), while new cost guidance was mixed – lower than our forecasts at Worsley, Cerro, and Cannington, but higher at SAEC and Illawarra.
Management noted an upside case of a 6Mtpa mining rate at Hermosa (3.3Mt base case). On Eagle Downs, the company believes it has a ‘mid-teens’ internal rate of return at consensus prices, with a production rate of 4.5Mtpa and a three-year build, although there was no mention of capital expenditure or costs. At Illawarra, the long-term plan is to get back to production rates of around 8Mtpa, while we forecast 7.5Mtpa.
Overall, our earnings forecasts have increased for the medium term after factoring in higher alumina prices and lower unit costs. Our valuation remains broadly unchanged, however, after also including higher capital expenditure.
We believe the business is in good shape with strong free cash flow yields, although South32 continues to trade close to our net present value measure. We will look to become more positive at a lower entry point or when there is greater confidence around development projects. For now we maintain our Hold recommendation and have trimmed our target price to $3.80 from $3.90.