Fat Prophets Hot Stock - South 32

Wednesday 9th November 2016

What’s new?

First quarter numbers from South32 reflected a somewhat challenging trading environment, with the miner having reported softer production outcomes across all, bar one, of its product offerings. While management’s guidance for 2017 has at this stage remained relatively unscathed, there is a risk of a downgrade if the current operating environment persists for the balance of the fiscal year.

Looking at the key numbers from South32’s first quarter, we note that zinc production printed a fall by 9.7% compared to the first quarter for 2016, to 17,700 tonnes, with management having attributed the decline to the planned processing of lower grade ore during the period.

Alumina also turned in a softer operational performance for the first quarter with the printing of a 5.2% fall on the comparable period last year to 1.3 million tonnes. The softer performance was driven by infrastructure availability issues at the Brazilian operations and a planned maintenance shut-in at the Australia operations.

Downstream from alumina is the company’s aluminium operations, which printed a flat result for the first quarter 2017. Group wide aluminium production came in at 243,000 tonnes for the first quarter 2017, compared to 244,000 for the first quarter 2016.

South32’s metallurgical coal reported a fall of 31% for the first quarter 2017, to 1.4 million tonnes and energy coal a 5.8% fall, to 8.7 million tonnes, with both results compared to the first quarter 2016. Management attributed the marked decline in metallurgical coal to challenging geological conditions at the company’s Illawarra operations, which were rectified late in the period.

The production of manganese ore for the first quarter 2017 fell by 18% on the same quarter for 2016, to 1.2 million tonnes.

Outlook

Despite the softer first quarter, management has retained the bulk of its production guidance for 2017. The two exceptions to this being South32’s guidance for metallurgical coal, which has been revised down to 7.55 million tonnes from the previous eight million tonnes, and energy coal guidance, which has been revised up to 1.5 million tonnes.

Management also indicated that South32 remains on track to achieve its cost reduction targets for 2017.

Price

From a technical standpoint, the recent and rapid increase in South32’s share price has resulted in the RSI venturing into overbought territory. While this suggests that there is a risk of a temporary pullback in price down to support situated at $2.35, medium-term momentum remains in favour of the bulls, as the share price has comfortably cleared the 50-week moving average (red), with the recent break and close above the 78.6% Fibonacci retracement of $2.03 also providing positive support.

Worth buying?

We believe South32’s suite of assets certainly have the capabilities to generate gains in shareholder value. The requisite long-life and quality we look for, and being positioned in the competitive part of the appropriate cost curves; are key attractions, with the overall investment case being supplemented by a robust balance sheet, positive cash flow profile and experienced resource team.

David Lennox is a senior analyst at investment research and funds management house Fat Prophets. To receive a recent Fat Prophets Report, CLICK HERE

Disclosure: South32 is held within the Fat Prophets Mining and Resources, Concentrated Australian Share and Concentrated UK Share portfolios.

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