South32 Limited (S32) Earnings Call Transcript & Summary

Thank you. Good morning, everyone, and thank you for joining us for our financial results conference call for the half year ended December 31, 2021. Our Chief Financial Officer, Katie Tovich, is also here on the line. And I have our Chief Operating Officers, Jason Economidis and Mike Fraser, joining us on the line as well. Look, there's a short video which provides an overview of our financial results available on our website, so I'll keep my introductory comments relatively brief, and then we can get into some of the detail, if you like, in the Q&A. Look, I always start with the point that we have a strategy that's been in place since day 1. It's a simple strategy that we think is fit for purpose across all cycles. It is underpinned by a belief in a strong balance sheet and a focus on a disciplined application of capital. And if I sort of break that strategy into components, the first piece is around optimize our existing operations. I think in the period, you would have seen that we had another good operating performance from the teams. We achieved production records at Worsley Alumina, Brazil Alumina and GEMCO. We've upgraded the full year guidance at Illawarra Metallurgical Coal, Cerro Matoso and Cannington. And the volume efficiencies and cost controls that the teams have achieved mean unit costs are well controlled despite strengthening currencies. It's great to see that our core markets are rebounding, and we've seen our prices start to reflect this and increase at the start of 2021, which gives us confidence going forward. As a consequence, we announced today, we'll be paying a dividend of $0.014 per share, and we increased our capital management program by USD 250 million, with USD 259 million to return by September '21. It's also good to see the teams doing a lot of work on the second pillar of our strategy, which is around unlocking the full value of our business. You would have seen us announce that we accelerated the development of the Q&P project at Cerro Matoso and the progress and numerous improvements in life extension studies across that business and other businesses, a couple of examples being the rolling of the energy efficiency technology we're rolling out at Mozal. And we're also looking at that being incorporated at Hillside by doing the study. And we've also got a number of decarbonization studies ahead of us releasing our updated targets later this year. At the same time, we continue to work the portfolio, which is the third element of our strategy, by continuing to exit low-returning businesses. GEMCO is now gone. Metalloys is on care and maintenance and South Africa Energy Coal is progressing. We have also, in the half, unlocked value through the sale of a noncore precious metals royalty portfolio. And at the same time, while we're surprised by the IPC decision, we've got a number of options we'll look at that I'm sure we'll dive into today on that space. We've also established an attractive pipeline of growth projects. The studies at Hermosa are progressing, with Taylor due at the end of this financial year and Clark in the first half of FY '22 in terms of the concept study. The annual pre-feasibility study will be completed with the exploration program starting this season, following the COVID impacts from 2020. All our growth initiatives in our drive is around increasing our exposure to the base metals that we think are important for a lower carbon world. It's reflected also by the 20 exploration partnerships we have achieved with companies which have a bias to base metals. If you think about our balance sheet, it remains strong. We exited the half with $275 million worth of net cash, and that has grown to USD 452 million by the end of January with working capital unwinding, as expected. Our buyback is continuing, and there are major catalysts coming that will move the quality of the portfolio forward in the coming year. With that, I'll open it up to questions.

[Operator Instructions] Your first question comes from Paul Young with Goldman Sachs.

First question, Graham, is on Illawarra and Dendrobium Next Domain. Can you just talk through what is a realistic plan B as far as a mine redesign there and what that could look like just conceptually? And second to that, on the base case assumption -- or the assumption, I should say, that you cannot get a plan B up through the IPC, what does Appin look like on a medium- to long-term basis as far as all-in costs at that operation? When you move to the longer panels, just conceptually, what would the cost structure look like at Appin if it was running stand-alone?

Yes. Thanks, Paul. Appreciate the question. Perhaps if we start, I guess, and take a step back and we think about the complex that we have there, obviously, we have Appin and Dendrobium. Appin itself is obviously the base of the business. And as we've spoken about over the last period of time, we've been executing a plan to sort of get Appin back to its nameplate capacity. It was great to see again the teams return to that 3-longwall configuration layout across the whole complex. Obviously, our guidance this year is being upgraded by 4% to 8 million tonnes. The hybrid plan that we talked about at Appin is maximizing productivity of the 2-longwall phases, and that continues over the next 3 years. And then to your point, Paul, we've transitioned to a simplified mine layout with larger panels through FY '25. Previously, we've spoken about getting back to that 7.6 million tonnes with an all-in cost of about $100 a tonne. If we sort of look at Appin only and talk about that new plan, to the point you made, that plan will be going to the longer-length longwalls, reduces the number of longwall moves. We don't have the same delay with relocating longwalls and we benefit from further productivity. For example, there's about 30 kilometers left underground development of the sewer vent shafts. You go from 4 to 2. We continue with mines with a drop from 7 to 4 and we only have less gas rigs. I think your question around the cost is a good challenge. If we have a look at where we are today, obviously, Appin's cost base, excluding sustaining CapEx, was about $112 a tonne and about $27 a tonne in FY '21 for sustaining CapEx. If you think about where we would aim to be beyond FY '25 with these changes, we'd be pushing for an all-in cost at Appin at around $100 a tonne. That's certainly the objective of Jason and the team. To answer your question around the IPC, look, the IPC, it is fair to say that our submission around Dendrobium, which included Area 5 and Area 6, to be clear, that was an unexpected outcome from the IPC not only for us but probably all the stakeholders. So that is something, obviously, we're engaging with all the key stakeholders now about what the way forward looks like. From our perspective, there are a number of options that we have in terms of how we go forward. One is to appeal. The appeal is basically on process, not merits. We can seek to have a government intervention, we can submit a revised plan or we can accept the decision. But before we maybe sort of dive into that detail, I think it is important to sort of recognize that we also have some other options around Dendrobium in the short term. Clearly, we've already got some work underway in the areas we're currently mining. We essentially have some opportunities around Area 3C, even though longer term, that has some gas challenges around extraction. And then there's potentially some regular mining. So we think there's some work we can do with Dendrobium. But obviously, our preferred case is around doing Dendrobium Next Domain, which is essentially Area 5. What we will have a look at now is, obviously, what options we have around the revised mine plan that makes economic sense, addresses some of the concerns potentially that were raised by the IPC. But at this stage, Paul, it is too early to make any decisions because the team is just commencing that work. But what I would say, the important point is, if you think about the base business, Appin, the team, absolutely with the redesign that we've put in place and talked about over the last couple of periods, has the opportunity to get to roughly an all-in cost of $100 a tonne.

Yes. Great. Good info there. I've got a second question on the portfolio more broadly over the long run, now that Eagle Downs is out and some challenges certainly on Dendrobium Next Domain. If I look at the pipeline, obviously, Hermosa is still -- it's a big project. It will take multi-years to execute on. There's lots of upside through the drill bit, et cetera. Trilogy is more longer-dated. It appears sort of 2030 as far as potentially first production. It looks like there could be a little bit of a gap there, 3 or 4 years, where post the build of Hermosa and before you get stuck into Trilogy. Just thinking around about your pipeline and options. I know you're doing all the farm-ins, which is the right thing to do. But do you think you need another larger project? Or can you take on another larger project, say, in between Hermosa and Trilogy?

So I'll start with, Paul, I think they're all good questions. And certainly appreciate there is a potential time lag with the development of post-Hermosa in terms of Taylor and Clark. And obviously, Arctic is a bit further out as we've always spoken about. I think the critical point for us, Paul, is what we did with the existing operations. And I think it was great to see, for example, the work that's been done at Cerro Matoso around basically Q&P but also some of the work that we're now doing, if you like, around the next stage of development for them, which is really around ore sorting and the mechanical ore concentration project. And that potentially has the ability to increase the processing capacity by 50%, offset some of the grade decline but also getting the extension on what's called Contract 51. We've also got Hillside AP3XLE. We're looking at it. We've been implementing that in Mozal at the moment. So the existing operations are working what they can do to sort of look at growth and how they contain or sustain their production levels. I think, look, the gap in between when we develop our first project, you can look at that in 2 ways as: One, we generate more cash than we need. So hence, we'd look to return it back to our shareholders because we don't believe in carrying excess capital. The second thing is, there may be opportunities that come our way. But again, we're not fixated as an organization on chasing volume over value. So we'll always be ready to look at opportunities, whether they be new projects or maybe potentially M&A. But it's always going to be through that lens of how we create value for our shareholders. We're not driven by increasing our production just to satisfy people. It's going to be about how we create value for our shareholders. So you should expect us to be continually disciplined in that space.

Your next question comes from Lyndon Fagan with JPMorgan.

Graham, just to expand a bit more on Cerro Matoso. Can you perhaps shed some light on the medium- to longer-term production expectations we should be expecting out of that asset now, given the changes?

Yes. Look, I think that is certainly something, Lyndon, we'll give more detail on as we do some more of the work. I mean, obviously, we've given some of the guidance around what, if you like, the actual Q&P project looks. I mean, essentially, that would allow us to lift our production for a period of time. We're probably between FY '22 to '28, we'll be slightly pushing the production up. I mean, our objective at Cerro Matoso is to roughly get to 40,000 to 42,000, if you like, tonnes of nickel produced there. And we think that's about the right level we're aiming for with the number of different projects the teams are working off. The team at Cerro, look, I think they've just done an amazing job over the last 12 months. As they battled COVID-19, they developed these options as well as they've done a major furnace rebuild. And if you recall, that major furnace rebuild also opened up the envelope to allow our strategy to process the material. So that 40,000 to 42,000 is probably about the right number we're looking to achieve.

Great. And I suppose I'll be the one to ask it. Anything you can say on the South African Energy Coal sale just to update us on progress?

Yes. Look, probably not a lot new than we've disclosed in the past. I mean, it does feel like it is taking time. But I guess people have got to understand that's in the backdrop of a country at the moment that is having a huge battle with COVID-19. But we're working very closely with Eskom at the moment through that approvals process. Obviously, we've got South African competition. We've got the Department of Mineral Resources and Energy, the minorities that own the share in South Africa who are just trying to exit for a nominal amount. We're engaged really extensively with both Seriti and Eskom and are making good progress. We're still on track, we believe, to complete it by the end of March this year. And certainly, all the signs have been positive from the government interactions. There's just a lot of distractions in the country at the moment.

Great. And look, final one from me, if I may. Just with -- great to see the buyback capital return amount. Can you steer us in any direction about how you choose to allocate money between a buyback and a dividend going forward?

Yes. Look, Lyndon, I'll pass that one to Katie as she runs the -- that capital allocation framework.

Yes. Thanks, Graham. Look, I mean, maybe just to reemphasize, our capital management framework is unchanged. And we obviously set within that, we have the minimum payout ratio of 40%. And as we see earnings expand, we expect to return incremental dividends via that mechanism to our shareholders. We've got a capital management program that's flexible, and we've always said we seek return cash to shareholders in the most efficient manner, and we don't plan to carry excess cash. So at current share price levels, we certainly see value in our shares at this level. We also believe in the longevity of our capital management or market share buyback program. And so we do intend to continue to buy through the cycle while we see value. We do have that flexible execution approach, where we buy higher volumes at lower price. And if you look back through history, you can see we've had some good success in terms of the value approach to that dividend -- sorry, that buyback approach. But I do think it's worth noting that we can switch, and we continue to assess that right form of return as we progress through the execution of the program.

Your next question comes from Kaan Peker with Royal Bank of Canada.

Just on the portfolio, maybe extending on Paul's question. Is the ability to take on additional projects dependent on the South Africa Energy Coal sale? And maybe -- I mean, it's been deferred in the past. But just wanted to check if you've got an update on how much capital you believe will be freed up post the sale or post the divestment of the South Energy -- South Africa Energy Coal asset? And I've got another question afterwards.

Okay. Well, maybe I'll address the first question. Look, from a portfolio perspective, there's nothing more important enough in terms of completing that South Africa Energy Coal transaction. Now we've talked in the past about the complexity that, that business brings in terms of physical size and footprint, just the sheer number of people, plus the government involvement through the state-owned enterprise, Eskom, Department of Mineral Resources and obviously, National Treasury. It's a complicated business. And you can look across the industry at the moment and just look at the results over the last 6 months, where there's been roughly losses of $1.5 billion in most of the energy coal businesses because it is a business long term that we don't think fits with a company like ourselves. Look, from our perspective, it is about completing the deal for those reasons. There are other benefits in terms of, it does obviously help us from the balance sheet perspective because if you look pretty much day 1 of that business to where we are today, it's always been a drawdown on cash. And it also has large closed provisions but recognizing those closed provisions are quite long dated. So it certainly has those challenges. And then maybe, Katie, you can add some thoughts about how you think about the balance sheet post-SAEC.

Yes. Thanks, Graham. Certainly, in terms of sustaining capital, we do see that our sustaining capital will reduce post the divestment of South Africa Energy Coal in the region of around about $100 million a year. So certainly, from a capital intensity perspective, that will be accretive to the balance of the portfolio. The other element that we've talked about, so we'll be freeing up our balance sheet in the context of provisions. And you will note that South Africa Energy Coal has, at the moment, about $870 million worth of rehabilitation provisions associated with it. So that's about 35% of our total provisions. So we will release those also as we divest South Africa Energy Coal. And those elements will be reflected as we reconsider our optimal balance sheet, as we've said, post the divestment of SAEC.

But I also wouldn't just sort of close that out. I wouldn't want to -- people to think that we're building a war chest for our balance sheet to go out there and do M&A or make decisions. We will continue to focus on growth options as we have in the past. It's all about creating value, not chasing [indiscernible] units. That same discipline worked so far. Is there a second question?

Sorry, just finding a bit tough to hear. But just on that, I sort of -- I missed that last part. Hello?

Okay. So let's see if I can -- we're losing [Audio Gap] might view it online. We'll wait and try to take the next question and see if we can circle back.

Your next question comes from Hayden Bairstow with Macquarie.

Yes. I'm having the same problem in terms of dropping in and out a bit. Just a quick one on Cannington. I mean, obviously, you sort of lifted this year a little bit. Just interested in sort of the outlook. I mean, you haven't provided a full year guidance previously. What -- how do we think about that as some of these high-grade areas likely to deliver better results into the sort of medium term and the rest of the project and the reserve upside? Just sort of trying to get a better feeling for that. And then just on manganese in the NT, just obviously, that's on reserves. It has a reasonably short life. There's obviously potential to convert all of that. I mean, just some timing on when we might see updates to the mine life assumption at GEMCO.

Yes. Maybe I'll deal with the manganese one and I'll get Jason to talk about the Cannington one. I mean, obviously, GEMCO has the beauty of, I guess, of being the best asset in the industry from a unit cost basis and grade and also proximity to the customer. Look, we have a number of different options on the go at the moment around GEMCO. As you rightly pointed out, at the moment, we have about 5.7 years' worth of reserve and about 11 years of resource. At the moment, the team has been working hard to basically get into the Eastern Leases, which essentially has a project moving into feasibility, where we'd expect, if you like, the final investment decision on that to be made around May '22. And first production will be about FY '25. And that will basically work for about 3 years. That will move, if you like, from the resource to the reserve. I think the -- and they'll probably scrape out another 2 or 3 years on other work they're doing around just general stuff around the property. I think the big one for us is really around the Southern areas. And the Southern area is just a large, unexplored area, free to work, the way we've been doing over the last 12 to 18 months. We are in stage 2 of that exploration program that will run for roughly 2 years. In that, we'll do about 94 kilometers of new drill lines. And pads, we'll do roughly 792 RC drill holes, of which we've probably completed, I think, roughly last summer of just around 220 at the end of December. And we'll really start the program in 2021 when the dry season is sort of back. And we expect to complete the drilling in FY 2021. The challenge with the Southern leases is really understanding what we have: is it 2 or is it 5 years or is it 10 years? We just haven't done enough work, but we should talk about that towards the end of this calendar year -- sorry, on our Q2 -- sorry, calendar year 2021. Maybe, Jason, do you want to talk about Cannington and where they're at?

Yes. Thanks, Graham, and thanks for the question, Hayden. Look, Cannington is actually stabilized in production. I think our access to high-grade stopes continues. There's no sort of -- nothing -- no impact sort of foreseen in the future. We've got some studies underway at the moment looking at different areas that we can go into. So I'm not sure if there's anything else you wanted to ask, Hayden, but Cannington's in good shape.

So I think Cannington is running well, Hayden. I think the one thing that we've always flagged is obviously the mine is in excess of 20 years now. The shaft itself, we've talked about eventually what do we do with that shaft because eventually, you've got to move out of the shaft because it actually has high-grade ore in there and probably the highest grade ore in the mine at the moment. So certainly, one of the initiatives that Joe has been leading, Joe, who runs Cannington, is what is the right time to sort of literally from using the shaft that's taking tonnes up to actually going back to If you remember, during the rough replacement underground, we were sort of roughly, for a period of time, 100% trucking more out of the mine than we've done it in the past. That's a trade-off study that the team's sort of focused on. I think to Jason's point, mine production is back up to where it needs be and we always have extra capacity. I think the key for them at the moment is, as we pointed out in the past, you don't have that many different, if you like, options to sort of move the mine sequence because of limited openings. I think what I would say the team has done a really good job on is going back to some of the old stopes that we've talked about, cutting in half and accessing. I think the more we've done that, the better the team's got around productivity. So what you should expect: a, there's still some fluctuations in price we described from stope to stope because the sequence is pretty offset. The only big change is potentially around if we get into the shaft earlier.

Yes, okay. So year-on-year fluctuations still likely. Okay, cool.

So I imagine, we'll make a decision on the shaft within the next 6 months to give you a timing of what that looks like.

Your next question comes from Glyn Lawcock with UBS.

So a few quick ones, hopefully. Just in the report, you talk about your long-term coal supply agreement, and you're going to assess the impact from the IPC ruling. I'm sure we should know this. But could you just refresh, so what is that long-term coal supply agreement? I mean, are you having to supply coal? And what's the risk like if you can't -- have to shut Illawarra in '24 because you can't make it work? That's the first one.

Yes. Look, we obviously have a -- you'll see in our sales numbers, we have a domestic product that we actually sell to BlueScope as well as we sell a little bit to . I mean, that contract has been, since the demerger of this business from BHP many years ago. It's an interaction, if you like, over a long period of time. That plant is actually sort of based on their lease. They obviously have specifications around what they're looking for in tonnage, Glyn. That's something we engage with them on a regular basis as the mine plan changes. In many ways, when you have some of the challenges around China and other places in placing a product at the moment, it's natural to hedge that. So we have a good relationship with BlueScope, and we'll continue to work through that as the mine life changes and the composition of the plan changes.

But is it a supply or a pay agreement sort of thing that if -- you have to provide coal for a certain period? Or this closure unexpectedly could negate your obligation under that supply agreement?

Yes. Look, probably some commercial sensitivity around some of the details of the contract. But what I would say is it is a turndown contract. There are some bets in debtors, of course, contained in that contract. But also, both parties recognize that the coal could lead to changes over time. So we work through that in a good way.

Okay. And then just -- you spoke a lot about Eskom already. And obviously, the SA Coal sale would -- you will have seen overnight the deal that Eskom has just been allowed to put up price hikes by 15-plus percent. How does that play into what's happening? Is that something that had to happen to help you move forward on the sale? Or are they completely separate events? So I'm just trying to understand if that's a positive for the sale process.

Look, that's -- I mean, if you think about Eskom at the moment, they're a stand-alone enterprise that's under pressure [indiscernible] reliable base at a competitive price. Their balance sheet is stretched. So one of the things they are looking to, obviously, is the way that we get to increase prices [indiscernible] decide if they're looking to pursue a high-quality [indiscernible] from a variety of different sources. We actually think, while we're not focused on the revenue side, that their component has started impacting us, I'd say. We're more focused on how do we help them out on the coal side. And we think part of the attractiveness of the deal with Seriti is the combination of the 2 resources. And the infrastructure actually allows them to lower their average unit cost of coal per yield. So I think from that side, where it is walking the other side on the expense side, so I don't think it impacts our view whatsoever. Mike, you might have a frame and have a slightly different view being in South Africa reserve?

Yes. Look, nothing much to add from what Graham has said. I think the key issue here is Eskom is severely under pressure. They still absolutely believe their way out of their balance sheet pressure is through some kind of price relief, which they're obviously trying for so through -- in managing their revenue line. But I think as Graham has said, from our point of view, they're pretty separate. But I think if there is any linkage, it's really that they are talking to National Treasury about an integrated plan. And as Graham has said, I think the deal that Seriti brings in terms of their club deal is really one that gives them much more certainty on longer-term coal supply prices, which on the cost side, their primary fuel costs have really been climbing. So we do believe that this is a good deal for them, and they are very supportive.

Okay. Graham, can I slip in one quick one, if you may? Just the time frame for the buyback, is that over the next 12 months or 6 months?