South32 Limited (S32) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by. And welcome to the South32 Half Year Financial Results and Outlook FY '20 Investor and Analyst Teleconference. [Operator Instructions] Today's call will begin with opening remarks followed by a question-and-answer session. [Operator Instructions] I would now like to hand the conference over to Mr. Graham Kerr, CEO.

Thank you. Good morning, everyone. Thanks for joining our financial results conference call for the half year ended 31st December 2019. I'm joined by our Chief Financial Officer, Katie Tovich; and Chief Operating Officers, Paul Harvey and Mike Fraser. Given there is a video providing an overview of our results available on our website, I'll start with a short introduction. Volatile markets led to a 21% decline in the average realized prices for our key commodities, and we reported underlying EBITDA of $678 million. Free cash flow from operations was $284 million, and we ended the half with a net cash balance of $277 million. We remain committed to a strong balance sheet, and our capital management framework is unchanged. Reflecting our strong financial position, positive outlook for our business and disciplined approach, we declared a fully franked interim dividend of $54 million and a special dividend of $54 million. This takes total returns to shareholders, including our on-market share buyback, to $300 million in respect to the half. We also increased the size of our capital management program by $180 million to $1.43 billion, leaving $198 million expected to be returned following payment of the special dividend. We remain focused on sustainably improving our operating performance, both in terms of productions and costs. We increased the output at Worsley Alumina and had record production at Brazil Alumina. And the majority of our operations, production is either on track or ahead of plan for the year. At South Africa Energy Coal, we have lowered production guidance to the bottom end of our range in response to challenging market conditions. At our South African manganese operations, we curbed higher cost trucking in response to lower prices which we continue to monitor. Unit costs were sequentially lower at the majority of our operations, supported by a broad appreciation of the U.S. dollar and their strong operating performance. Heading into the second half, we have lowered our 2020 financial year cost guidance for all operations aside from South Africa Energy Coal. Looking ahead, we continue to reshape and improve our portfolio. Our agreement to sell South Africa Energy Coal is expected to be complete by the end of the calendar year subject to meeting a number of material conditions. During the half, we exercised our option to form the Ambler Metals joint venture in Alaska, funding the investment from cash on hand. A pre-feasibility study for the Arctic deposit will be commenced, while we continue to explore the bornite deposit in the broader land package. At our higher grade Hermosa project in Arizona, a pre-feasibility study is due in the June 2020 half year. The initial JORC resource to the total deposit has increased our confidence while initial JORC resource for the Clark Deposit is also expected in the 2020 calendar year. We're focused on sustainably improving our operating performance and reshaping our portfolio. These priorities, underpinned by a strong balance sheet and capital discipline, will continue to create value for our shareholders. Thank you. And I'll be happy to take any questions you may have, and I'll now hand back to the operator.

[Operator Instructions] Our first question today comes from the line of Sam Webb from Credit Suisse.

I was wondering if you could just put a bit more commentary around manganese, if you could. Obviously, prices have lifted. Have you resumed any of your trucking yet? Or do you intend to this quarter, next half, given the change in market conditions? And as to manganese, can you provide a bit of color around any progress or otherwise with regards to the smelters and the review of those operations, please?

Yes. Look, Sam, maybe I'll tackle the last question first. When it comes to both the Metalloys smelter in South Africa and the TEMCO smelter, we're still on the same course of looking at all 3 options, which include either complete closure, mothballing for a period of time or divestment. Obviously, divestment we think is the best outcome for all our stakeholders, including our employees, and that's something we continue to progress. And ideally, we'll be able to update the market as we get closer to the end of the financial year. In terms of the manganese market, so I guess, what you -- it's been, I guess, a tale of 2 halves in the first 6 months of the year, and I'll talk about that, and then I'll talk about the outlook going forward. Clearly, we saw commodity prices, particularly in our manganese area come out of a severe pressure as we sort of move through the second half of that half. If you think about our trucking, we expect it to basically -- if you look at the first half, we trucked about 27% of our products. In the second half at the moment, we're forecasting about 6%. We did obviously see quite a reasonably large build of stock, if you like, in manganese in South Africa. It's approximately just under 5 million tonnes at the moment but I think it's important to understand, with the increasing dependence on the Chinese of imports roughly about 90% now, that still only represents 1.5 months' worth of inventory. So while it's increased in total, I think the total import is sort of distorting that number slightly. I think what we did see for a period of time when manganese came under increased pressure was the prices did dramatically drop. And as we've seen in the past, we saw a lot of the higher cost trucking, including our own, drop out. And that particularly occurred around September, October, November, when we start to see that shift. What it was actually good to see. If you look in November, we saw where we had low prices $3.68 per dmtu move to $4.30 by the end of January. And that really reflects, if you like, the steel production and some of the restocking that's going on by the alloy producers. Look, in the short term, we probably expect, if I look at current market conditions and demand we're seeing from our products kind of optically, we actually think there's going to be potentially a little bit of push up in price. But I think longer term, so if we think beyond the next couple of months, depending on how the Chinese come out of Chinese New Year and steel demand will have a big impact on the prices. So we'll watch that with interest. I think if you think about the medium to long term, we haven't changed our view in terms of the South African underground mine will be the marginal producer, and we still see that price being a healthy price to keep the industry in balance. So from that perspective, while we have seen some noise around it, we are seeing the market respond as we've always expected. Does that help, Sam?

No, it does. Just 1 follow-up quickly. Just you said stocks in China slightly under 5 million tonnes, what did they -- to give us context, what did they top out at?

Look, I'll say at the moment, they're probably about 4.7 million tonnes, I probably rounded it up to 5 million tonnes. I think they probably got closer to the 5 million tonnes mark in October. But again, if you look in our presentation pack, you will see that we actually show a slide -- because historically we have really just used that size of the stockpiles in China as a reference point but I think the big change over the last year has been, when you've seen China now relied about 90% of its product to be imports instead of domestic production, it is probably more important to focus on the months, if you like, and we think it's about 1.5 months' worth of inventory there, which probably isn't outside the norm.

Your next question comes from the line of Hayden Bairstow from Macquarie.

Just a couple for me. Firstly, just on the growth projects. Just interested to just understand, obviously, cash flow has come down a fair bit from where it was in the last couple of years, just how you're thinking about sequencing all of those, assuming Eagle Downs and Hermosa and obviously Dendrobium are all sort of going ahead. I mean are you in a position to do all of them? Or do you need to sort of start thinking about sequencing? Or is project timing sort of okay on that front? And just a quick financial one, just on the working capital gain on receivables. Should we expect some sort of reversal of that in the second half? Or are you actually trying to push better working capital management?

I'll let Katie answer the second one in a second but I'll start with the first one. If you talk about our development projects, I guess, I'd start by the position of stating, look, compared to where we were 2, 3, 4 years ago where we had no options, we're in a much better position now in terms of we have options to decide where to deploy capital. I think what hasn't changed from day 1 is our capital management framework. And in line with that, every option we have in the portfolio, whether it be returns back to shareholders, investing in new projects or the existing business will always be subject to competition to drive the best outcomes. If you think about the sequence of the new projects that are sort of being brought into the group, particularly if you think about Eagle Downs and you think about Hermosa in terms of multiple stages in terms of potentially Taylor 1, Taylor 2, Clark and then the other land area, and now Trilogy, they're actually all quite staged, if you like. So there's not a huge overlap of capital. So I think that's something that sort of we think about when we look at the cash flow forecast. And if you think about our numbers and we run, obviously, our internal numbers on a frequent basis, we believe that we can afford to continue with our current approach around dividends, capital management, where we believe in being consistent through the cycle and fund those projects in terms of the way they're sequenced. Now in saying that, there is no guarantee that every project goes ahead. If you think about today where -- Hermosa stage 1 with Taylor, we're doing a pre-feasibility study that we expect to be finished by the end of our financial year. If you talk about Eagle Downs, that's more advanced in terms of feasibility study. It has some of the advantages, if you like, of more construction being complete. So it has already progressed in terms of some of the drifts and the infrastructure around that project, and that's fully permitted. But at the same time, there's competition in the Bowen Basin with a number of new mining developments. We've got access to critical things like water but we still need to work out access to the port and rail. So I think they're all the things that will come, if you like, into the equation when you look at returns. But I'm certainly far more comfortable now compared to 3 years ago that we have a variety of options in that space. Does that help with the first question?

Yes, Graham. I just want to get an understanding if you feel like you've got limitations on these projects or certainly to add anything else into the pipeline at this point.

No, I don't, actually. I think we've got enough flexibility to move things around. I mean, obviously, we have put shareholders' money to work. So it's critical that we start generating a return on that. But I think there's enough flexibility in the portfolio on the cash management -- cash to manage that. But I think the most important thing for us, particularly around Hermosa, is to finish that pre-feasibility study. The focus on the last 12 months since the acquisition has really been about, a, progressing that pre-feasibility study but that's underpinned by the geology. But also finishing the voluntary remediation program and putting in place some of the infrastructure. I think one of the things we tried to include in the pack, for example, this time was a few fadeouts of the work that's actually been done at Hermosa because there has been a fair bit of work put in place around tailings facilities, set up of the potable water treatment plant and some of the basic infrastructure that project will need. And of course, we're in that unique position compared to someone like Rosemont, where the majority of our infrastructure, initial tailings facilities and production facility, we've built on state-owned or patented land, so we don't have the federal approval process. Katie, working capital?

Yes. Thanks, Hayden. I guess in relation to working capital, we did see a fairly significant unwind in the period. We would expect to see our trade receivables stay relatively constant at these levels and maybe come off slightly. But we wouldn't expect to see another large unwind.

Your next question comes from the line of Paul Young from Goldman Sachs.

A few questions, Graham, on the alumina market and also on costs. First of all, just on cost, to see really good performance on Worsley, good reduction in cost there. And your guidance implies, I think, a $12 a tonne reduction in the second half to that $213 a tonne. So just curious for this half, do you think this is close to the bottom as far as costs are concerned at Worsley on caustic and gas -- maybe gas price impacts? Then secondly, on the subject of cost looking at Brazil Alumina, costs were flat half-on-half. And you did have a $15 million impact from higher bauxite costs. Just curious about do you think that will all unwind in the second half? And then just on the market, Graham, I noticed that just very recently, it's obviously a lot of moving parts in commodities at the moment with respect to what's happening in China. We've seen some Chinese alumina production cuts and also a tick up in Chinese alumina prices and also seaborne. Just curious about what you're seeing in the alumina market at the moment.

Yes. No, thanks, Paul. Well, maybe start with Worsley because I think Worsley, as you're well and truly aware, has been -- it's something we've spoken about on a number of times, if you like, in the reporting periods. And if you go back to the E&G Project was completed well before the demerger, the 1 challenge at Worsley is after the E&G Project, it never consistently hit its nameplate capacity of 4.6 million tonnes in 100% terms. In fact, it's only hit it once. What we have done over the last 12 to 18 months is done a complete review of the calciners, which have really been the major cause of the instability in the additives we've seen. And if you think about where we are now, we've got 3 of those rebuilds complete. We've got 1 planned to be done in March. And then we've got 2 more minor pieces of work to be done in FY '21. What we are starting to see now in this first half is we're really starting to see stability coming into the actual plant. And as a consequence, we're starting to see the volume benefits. And that only not helps, obviously, with the unit cost reduction, but it really helps with the stability and the firefighting around the business. So I think that's allowing the team to start thinking about some of the costs. And clearly, in FY '20 when you add the hydrate sales, it will actually hit close to that nameplate capacity and certainly be up to full capacity in FY '21. And then like all good refineries, Mike and the team will be thinking about how they actually creep as they go forward. If you sort of talk about cost a little bit on Worsley. While we have incurred additional costs to do things like the calciners in this year and last year, that is starting to wind down. But I'd be remiss not to talk about some of the good things that we've actually seen the team do. You made the comment around energy costs. And as you're aware, we have some staggered contracts around gas that sort of, if you like, move over different periods. We have been in the process of renegotiating them. And out of that, we have actually seen roughly a $20 million per annum saving already in that space. We've also seen lower caustic prices, which obviously is out of our control. But at the same time, you have seen our consumption rates have dropped by about USD 17 a tonne in the half. And as a consequence, we have lowered our guidance by $11 for the full year, which implies we'll be doing a pretty good rate, if you like, in terms of the second half of the year. And we think the FX offers, if you like, a bit more tailwind. There certainly is a push on the team now that they've got stability in that business. Whereas as we go forward, we look at more cost opportunities around energy, labor, et cetera. But I think the team are doing a good job down there. The moving of Noel from running Hillside to Worsley, I think, by Mike has been a great move. If we talk a little bit about Brazil Alumina. I mean, obviously, I think you alluded to the major issue there, Paul, being around, if you like, the actual bauxite contract. The bauxite contract, obviously, is a component of us purchasing or taking the part that we have from MRN, putting it through the refinery at Alumar. And obviously, where there's a little bit of a shortfall, we actually buy some external bauxite. Probably the biggest driver of change in the first period of time has been that the bauxite that we purchase from MRN is basically tied to a 9-month lag, if you like, on the actual alumina price and aluminum price. So what you've actually seen flow through is higher bauxite costs, and we would expect to see that roll off as we continue to obviously get past that 9-month period. If you talk about the alumina markets, I mean, look, the market is interesting, obviously, at the moment because like all the commodities -- and again, to understand, there is absolutely no certainty in this space, and it isn't linear. But as we think about the impact at the moment, obviously, you've got the coronavirus having a big impact. We probably started the year thinking we're in a good position with, obviously, the U.S. and China getting some form of trade deal in place to build confidence back in the market. But obviously, what's happening now, if you like, with the virus is having an interesting impact. And to be honest, like I mentioned, it isn't -- linearity is different in different commodities. We're seeing some impacts when we think about alumina in terms of domestic production as they really try and tighten some of the quarantine. And as a consequence, the domestic alumina and bauxite, we see less truck movements and more of a reliance, if you like, on imported alumina. So that is actually having a positive push up on the price. Look, we think the market has rebalanced since we have seen the ramp-ups. There's probably a surplus of roughly 2 million to 3 million tonnes. But we have seen some volumes come out of the market with approximately 55% of the industry being underwater at those prices. We do expect some price support in the short term, and that really is around the supply disruptions in China, particularly the distribution constraints where the preferencing of imported material over domestic product driven by the extended holidays, the lack of workers at mines and some of the transportation, if you like, restraints -- constraints that have been put in place. Did that answer your questions, Paul?

No, that's very thorough, Graham. Thank you, I appreciate it.

[Operator Instructions] Your next comes from the line of Lyndon Fagan from JPMorgan.

First question, Graham, is whether you could give us an update on South Africa Energy Coal disposal and whether the sort of cut to CapEx guidance there has any implication on the transactional or how it sort of feeds through? And then the second question is, I guess, just while you're on the coronavirus, whether you could actually let us know if there's been any difficulty in selling product. How much product goes to China from you guys, and whether there's an interruption to shipping and all that sort of thing. Just be good to get some color there.

Okay. No problem, Lyndon. Look, we start the SAEC transaction, what you're always going to see in South Africa is lots of noise. Seriti here, who's the counterpart, is obviously -- we are closely talking to Seriti all the time. And if you think about those 3 critical approvals being around, the Eskom consent been around the DMRE approval, Department of Mining and Resources and Energy, and also the South African Competition, we jointly work together with those submissions on Seriti. And certainly, that engagement is still incredibly positive. There's some huge natural synergies that we've spoken about in the past about combining these 2 businesses together which are very attractive to the team at Seriti. In terms of how we're progressing in that space. I mean, look, there is no doubt if you talk about the operating business, you've seen us adjust unit cost guidance. You've seen us adjust volumes to the lower end of our range. That has really been driven by opportunistically focusing on cash. And in particular, stopping tonnes that are not making us any money. And Mike and the team, I think, have done a very good job on focusing on that. The most critical thing we're doing probably in the short term, Lyndon, is around pushing through those approval processes. We've been very well supported by the minister in terms of the Department of Minerals and Resources, Gwede Mantashe. He's been a very positive advocate of this transaction which is good for our Section 11 approval. The engagement with Eskom has actually been a really good engagement. The challenge with Eskom, obviously, has been the churn in terms of the CEO and the Chairman. But certainly, our interactions with Eskom, National Treasury leave nothing in my mind that we're heading in -- we're not heading in the right direction. That's been really positive discussions. And I really see it hard to be an issue with South Africa competition because they have 2 mandates. One is around competition, if you like. And the second one around is, is this good for South Africa? If you think about the transformation agenda, the black ownership, we tick all those boxes. So I think it's going to be a process in South Africa. There's always going to be noise. There's always going to be distractions. But at this stage, it feels like it's heading in the right direction, and Seriti is still positive or very positive. And certainly, our engagements with the government have been positive. Does that help with SAEC, Lyndon?

Yes, that's good, thanks.

We certainly don't feel like there's any slippage in the timetable. There's things that are always outside of our control, but we think we allow for that in that time line, and we'll continue to engage in a positive way. If you talk about the coronavirus, just moving on to that space, and maybe a little bit of a framing. If you think about our sales to China, and I'll take the first half of the year. The group overall, on a revenue basis, had about 22% of its products get sold to China. We have probably about 5% to 10% of our alumina book; 2% of our aluminum book; 64% of our manganese ore book; and about 10% to 15% of our met coal book. Well, all that sort of talks about particularly what's going into China, I think we'll be a little bit naive to say that, "Look, the whole world is feeling the impact of this so it is contagion onto other markets." But if you look at probably our main exposure in terms of manganese ore, that has been a market where, obviously, we've seen a shift in the price over the last month more on the positive sentiment upwards, and it wouldn't actually surprise me, Lyndon, if we don't see another short-term, if you like, push on that price in the next month because the demand for the product at the moment is actually quite strong. I think the more interesting thing will be how do they come out of Chinese New Year and, in particular, what does steel production actually look like. I think the positive on my side is we have seen the supply side respond as it always has, and essentially, that does mean that when the market comes under pressure in terms of price, we actually see, if you like, that trucking coming out of South Africa, and we certainly saw that high cost trucking drop off around September and October. But we have seen it start to reappear in January as prices have been more supportive. If the price does come under pressure, I'm sure that will react again. Look, when it comes to the alumina side, obviously, we spoke about some of the short-term impacts are seen there in terms of how they respond to the bars of some of the domestic supply drying up in terms of workers and availability. And certainly, some of the restrictions on transportation is leading to a strong push towards imports versus domestic products. Met coal is probably slightly different. Met coal at the moment, obviously, everyone's waiting to see, again, what happens with steel production, what happens with the quotas for this year. But I think the demand for high-quality coking coal is still strong. If you think about some of the supply disruptions you're seeing occur now in the Bowen Basin, another cyclone seen off the coast here, potentially even more rain. I think that is certainly in the short term, pushing the price of met coal up. And at the same time, the rebound, if you like, out of the monsoonal season in India was probably slower than we expected, and we expect some of that to be picked up in this first quarter and the second quarter of this calendar year. Does that, Lyndon...