South African coal exit a plus for South32, says Morgans

South32 coal mining at Klipspruit, South Africa. picture: Supplied.

South32’s imminent sale of its poorly-performing South African Energy Coal business has prompted analysts at Morgans to upgrade the stock from a “hold”’ rating to “add”.

Morgans analysts say in a research note that shares in South32 have been sold off due to market bias towards short term earnings momentum, but that the company was approaching a major catalyst in the sale of SAEC, with bids received.

“We expect the sale to be finalised in mid to late first half of the 2002 financial year,” they said in a note to clients on Monday.

As DataRoom reported this month, SAEC accounts for about 11 per cent of South 32’s earnings and it is understood to be working with investment banks Morgan Stanley and Macquarie Capital on a sale.

Some expect that the business will sell for about $1bn, but remediation costs, which some estimate to be about $700m, are expected to be carried by South 32. So in reality, the $15bn miner is likely to net about $300m for the operation.

South32 last week posted a solid fourth quarter operational result, with good performances from its Illawarra metallurgical coal mine, Cannington silver and lead mine and Worsley bauxite mine, despite SAEC dragging on group performance, the analysts said.

Cannington and Illawarra both beat 2019 financial year guidance and impressed the analysts.

Alumina, aluminium and manganese ore were steady for the year versus the 2018 financial year.

Before South32 divests South African Energy Coal, it will first write down a big portion of its remaining $US70m carrying value at its August result and is considering a sale of its underperforming manganese alloy assets.

“Selling its SAEC business is a major catalyst for South32,” Morgans analysts said.

“Assuming South32 does not recover material proceeds from the sale, we value SAEC at close to zero.”

Morgans says that the real benefit from divesting SAEC comes in how much it improves competitiveness in key areas of its business, including group margin, free cash flow generation, sovereign risk and strain on management.

Cost headwinds remain, particularly across its energy intensive aluminium assets and alloys.

“But we have formed the view we were too critical on how much operational expenditure would slip across the business,” Morgans’ note says

Morgans has lowered its near-term earnings forecasts for the 2020 financial year by 21 per cent, and its 2021 financial year forecast by 13 per cent on the back of weaker metal prices, particularly thermal coal and alumina.

“This adjustment has been somewhat offset by reductions to operational expenditure growth at Illawarra and Cannington, and extra production assumed for Cannington after assessing assumptions for the fourth quarter result.”

On the back of the changes, Morgans’ earnings per share forecasts for the next two years have decreased, with a smaller impact to valuation.

Morgans says it cannot pinpoint when the metal prices, which has driven the recent earnings downgrades for South32, will bottom.

“With the US-China trade war fuelling global aversion towards growth, (analyst) consensus has cut both South32 and most metal price forecasts aggressively.”