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Earnings head south for South32

Anthony Fensom  |  26 Aug 2016Text size  Decrease  Increase  |  

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Earnings headed south in fiscal 2016 for miner South32 Limited (ASX: S32), with the spin-off from BHP Billiton (ASX: BHP) posting a US$1.6-billion loss on the back of US$1.7 billion in impairments.

Hit by an average 21 per cent price reduction for its commodities, particularly aluminium and alumina, revenue dropped by 25 per cent to US$5.8 billion, with the company warning of continued tough times.

"I am not convinced we are through the challenging price environment. I'm sure there is still more pain to come," chief executive Graham Kerr told the Financial Times, warning of further job cuts.

Had it not slashed costs by US$386 million, South32 said it would have recorded an underlying earnings before interest and tax (EBIT) loss.

Instead, underlying earnings fell by 76 per cent to US$138 million, with basic underlying earnings per share of 2.6 US cents and a return on invested capital of just 1.7 per cent.

The Perth-based company declared an inaugural final dividend of 1 US cent a share, unfranked, as part of its policy of distributing a minimum 40 per cent of underlying earnings while maintaining an investment-grade credit rating.

Kerr said the company delivered "strong results" in its first full year of operations.

"We set five production records and achieved guidance for the majority of our upstream operations, generated controllable cost savings of US$386 million and reduced capital expenditure (capex) by US$306 million," he said.

"By optimising our operations and maintaining a core focus on value, we generated free cash flow of US$597 million and finished the year with net cash of US$312 million.

"Looking to fiscal 2017, we have maintained production guidance for the majority of our upstream operations and will stretch performance to meet cost targets."

South32 achieved record annual production at its Australian Manganese, Worsley Alumina, Brazil Alumina, Mozal Aluminium and Cannington mines, with "robust performance" at its other sites, while also implementing its new regional model of operations.

Australia accounted for 62 per cent of its earnings in fiscal 2016, followed by South Africa (27 per cent) and South America (11 per cent).

Capex is expected to remain "largely unchanged" in fiscal 2017 at around US$450 million, while the company said it was "well positioned to achieve the majority of fiscal 2017 operational cost targets".

Morningstar analyst Mathew Hodge has described South32 as a "second-tier mining exposure" with its assets "unlikely to generate sustainable excess returns".

"South32 has diversification through exposure to a number of commodities, including alumina, aluminium, manganese ore, manganese alloys, coal, nickel, and silver. However, with the exception of silver, all are tied to China's fixed-asset investment boom, which we think is finished. This is a material headwind for future earnings," he said.

"The generally mid-second-quartile operating cost positions and robust balance sheet are respectable. However, we think most of South32's commodity end markets are likely to suffer from weak demand and plentiful supply."

Shares in South32 fell following its earnings result, closing on Thursday 1.9 per cent lower at $2.01.

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Anthony Fensom is a Morningstar contributor.

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