South32 Limited (S32) Earnings Call Transcript & Summary

[Audio Gap] My research for Bank of America in Australia. Graham is our guest speaker today. Graham is the Managing Director and CEO of South32, has been with the company since 2014. And he was appointed CEO in 2015 -- sorry, was appointed CEO in 2014 and led the company through the demerger from BHP in 2015. Graham, it's a pleasure to have you here, and I'll hand it over to you now. Thank you.

Thanks, James. Thanks, everyone. It's interesting to talk about dates and times because tomorrow is actually our 7-year anniversary. And I guess, look, while it's great to be back here at the Global Metals and Mining and Steel Conference, we were going to use this as a platform to talk a little bit about how the actual portfolio has changed considerably from 2015 and also sort of harp on -- we're probably in the interesting position we haven't been before, where we've got a series of growth options compared to when we started 7 years ago. So we've got a fair bit to talk about, so I'll get straight into it. If -- maybe if we sort of talk about a little bit about our strategy. Our strategy remains unchanged. It's relatively simple. We started day 1 with the position of optimizing the assets we inherited as part of the demerger. And we really started day 1 with a cupboard, if you like, that was short of development options within the portfolio. There wasn't one. The other piece around the strategy is to try and bring new things into the portfolio as we thought about what we wanted to look like as we actually grew up. So I guess that asks a real question, what does South32 look like in 2022? And the reality is we look very different from what we did 12 months ago, and we look significantly different than what we did when we started in 2015. But the one thing that hasn't changed is our purpose. And while I won't spend a lot of time going through our purpose, we do think our purpose has really allowed us to position ourselves as a truly global and diversified producer of metals that is critical to, if you like, a low carbon future. If we sort of dive into that a little bit more in detail. One of the things that's underpinned our success to date is our approach to capital management and how we do that. That remains unchanged since the demerger, and it really centers on maintaining safe and reliable operations and an investment-grade credit rating through the cycle. We seek to distribute a minimum of 40% of underlying earnings as ordinary dividends, and you can see from the numbers on this slide here how that strategy has delivered to date. Since the demerger, we've returned $4.4 billion back to shareholders. We've directed $3.1 billion to create, if you like, value via acquisitions, and we spent $4.1 billion back in our own business to actually sort of unlock, if you like, some of those potential brownfield options to grow the business. And at the same time, while we started day 1 with a strong balance sheet, the balance sheet is even stronger today. And certainly, from our perspective, our approach of prioritizing high-returning options that compete for capital has seen us actually deliver a strong return on invested capital of 25% in the first half of FY '22. Interesting to listen to [ Chris ] talk just a moment ago. Sustainability absolutely is becoming at the full center when you talk about mining. And from my own perspective, having been in the industry for multiple decades, I've seen many times the positive impact that mining can have on the world and the impact that we can have on people and communities. Our approach to sustainability is focused on 5 interconnected pillars, which you can see on the left of this slide. And while we've done a lot of strong work in this space, we do believe we've got a lot of opportunity to really improve our safety performance. And from our perspective, in 2020, we embarked on a critical program of work to achieve a step change in our safety performance and support our aspiration of becoming an industry leader in safety. As I say to our people on a continual basis, nothing else really matters if we don't get this right. At the same time, we're equally committed to creating a work environment where everyone feels safe psychologically. And we've spent a lot of time and effort in getting the inclusion and diversity right to make sure that everyone in our business, no matter what their role is or what their background is, they're equally heard, and they can make a difference on delivering our purpose. Look, climate change is obviously on everyone's agenda at the moment. When we started South32, we set a goal of achieving net zero operational carbon emissions by 2015. But we've also set a target recently to half our operational carbon emissions, so our Scope 1 and Scope 2 emissions, by 2035. And we're directing some capital towards projects that will help us achieve those targets. Maybe sort of moving a little bit more on to the strategy piece of the session. One of the things that I think is really interesting, if you talk about the comment I made earlier about how much the organization has changed in 7 years, on this slide here on the left-hand side, you can actually see what our revenue used to look like at the time of demerger. At the time of the demerger, we probably had about 55 -- 53% of our exposure was to base metals, including the aluminum value chain. After a series of transactions and deals that we've done over the last 3 or 4 years, that is now closer to 74%. And we -- and with some of the future projects, you're probably getting much closer to the 80%. And that positions us very differently from day 1 where you -- again, you are that company that's well positioned to provide those critical minerals to the world as it decarbonizes. At the same time, on the right-hand side, while we've been helped by price, exiting some businesses such as South Africa Energy Coal, TEMCO and closing Metalloys, which are manganese alloy producers, we've actually increased our margins across the group, which I think has made a big change for us. If you thought of -- look at our portfolio, this is also an interesting slide. But when we started, as I mentioned, we had a set of operations we inherited as part of the demerger that had very little growth options, had relatively short lives. When you look at the organization now, it's quite different. We have a pipeline of projects to improve productivity and growth volumes in our existing businesses. We recently added copper through the acquisition of our 40% -- 45% interest in Sierra Gorda, and we actually reported for the first time in the March quarter copper production. We've also delivered the first metal from the restart of the 100% renewable power smelter to Brazil Alumina -- aluminum, sorry. And our next phase of growth actually comes in the base metal space with the development of our development options in North America, which we think is a strategically important jurisdiction for critical minerals. And we're starting to see some real momentum sort of happen in that space. At the same time, we probably believed in exploration very early on in the piece. And as a consequence, we have more than 25 active exploration programs currently underway targeting base metals. As a result of our recent strong performance, we have generated significant annualized cash flow in the past 4 months, and we are continuing towards directing this investment -- this cash flow towards investments that improve our portfolio, fund record shareholder returns and maintain that strong balance sheet. Our financial position is strong. As I mentioned, it's stronger than when we started post the demerger. We finished April with a net debt of $6 million, and that's despite recently completing the Sierra Gorda acquisition. So the group continues as we go forward to actually build cash flow with strong prices and higher earnings. But I think the one thing we're working through at the moment is in the last 6 months, we've seen elevated levels of working capital, particularly in the aluminum value chain. And that's through supply and port congestions, but we're seeing that starting to alleviate now. If you talk about the future, one of the advantages, I guess, of having growth options is you actually have money to deploy to generate stronger returns for your shareholders. And what you do see in this space here that we do have some opportunities to invest in a number of options. We will continue to allocate capital in a way that prioritizes safe and reliable operations while directing investment towards decarbonization projects in some of our business to achieve our targets. And at the same time, as you can see on this slide, when we talk about Hermosa, for the first time, we start deploying some material money towards our growth projects for the future. If you talk about returns, I think this is where we do have a strong track record of not only changing the portfolio, increasing our growth profile, but also returning shareholders back -- money back to our shareholders. If you look about our performance, yes, through our capital management program, we've returned about $1.8 billion to shareholders over the past 5 years, and we have about $268 million of the current program yet to run. We talk about returning a minimum of 40% of underlying earnings back to our shareholders. But when you include the actual capital management program, it actually reflects that during our time, we've returned 83% of our underlying earnings back to our shareholders over that time frame. And if you think about the impact of our on-market buyback, we've actually reduced, if you like, our shareholdings by 13% over the same time, which further benefits the per share dividend shareholders received through time. Maybe if we sort of take a little bit of a look at our operations and sort of give you a sense of where we sit as an organization. I'll start with our alumina and aluminum operations. In that position there, we have an integrated position that allows us to benefit from value shifts up and down the chain. And we've really seen that over the last 4 or 5 years as values moved up from alumina to aluminum and back and forth. Through our bauxite mines and refineries, we continue to deliver incremental improvements with debottlenecking at our alumina refineries following significant investment in that area. We have studies underway which will allow us to decarbonize Worsley. And at the same time, you've seen us increase our stake at the MRN bauxite mine by acquiring Alcoa's interest early in May, which allows us to further integrate our Brazilian operations from bauxite to alumina to aluminum. And the other important point, which I'll touch on later, is we're really growing our green aluminum position, which I think is incredibly important. Our base and precious metals operations are diversified across copper, nickel, zinc, lead and silver. In February, as I mentioned earlier, we acquired a joint control interest in Sierra Gorda, which is a large open-cut operation in the Antofagasta region in Chile. At Cannington, our underground silver, lead and zinc mine in Queensland continues to work along optimizing the ore bodies. We actually transitioned to 100% trucking in the current quarter, and that allows us to bring forward higher-grade material costs without increasing costs. At the same time, I think Cerro Matoso for us has been a great example of taking an asset that was unloved and actually delivering a series of projects that has extended the life and increased the returns on that. And at Cerro, the guys have done a great job in terms of first doing basically the smelter, then actually opening up the QMP pit. And now they're completing the OSMOC improvement project, which potentially allows us to extend the life of the mine by another 15 years. If we sort of look at our steelmaking business. We produce high-quality manganese ore in South Africa. We have coking coal for steelmaking at our Illawarra mine in Australia. And we have actually increased -- another good example of some of the work the team has done, we've increased our manganese ore volumes by 21% since the time of the demerger. So that's been an area of strong growth for us, and we are currently undertaking studies and exploration programs to extend the life of GEMCO and also, at the same time, looking at what we can do to expand vessels and increase, if you like, our rail loading infrastructure to allow us to get more product to market via the rail. At Illawarra, we recently resubmitted environmental approvals for the continuation of our mining activities at Dendrobium, which is part of the mining complex here alongside Appin. And if approvals are granted and the Board approves it, it will extend the life of Dendrobium to around 2041. But probably the area I was going to focus on a little bit more in this presentation before we go to Q&A is to actually talk about growth. As I mentioned earlier, growth is not something that we started with when we actually commenced South32. But now we actually have quite a strong growth pipeline when you think about our business. On this slide here, you will see from a base of FY '21, we expect from a copper equivalent basis to actually grow our production by 20% in the next financial year. And that really is driven by the acquisition of Sierra Gorda, the restart of Brazil aluminum, if you like, with renewable power, the increase in our Mozal Aluminium stake of 16.6% and some of the creep that we're seeing naturally occurring in our business around things like Worsley, where we're increasing our throughput capacity. So that positions us well as we think about how we grow the portfolio. And it's more than just what we're seeing in the next 12 to 18 months. On top of that, for example, if you look at Sierra Gorda, at Sierra Gorda, while there's some real valuation impacts which we think increase our earnings today, it brings with it, if you like, a lot of opportunity to grow the business. Through the current debottlenecking project that's underway, they've got about 110 million tonnes of an oxide project sitting on the surface, which is currently going through study phase. And at the same time, they're looking at a fourth line, which will allow us to substantially increase the capacity that exists in the processing facilities there. All things that we see, if you like, sets up the business well for the future. At the same time, I talked earlier about increasing our stake in, if you like, green aluminum. Over the next 12 months, we'll actually double our green aluminum production. And that will be really driven by the restart of Brazil aluminum smelter, that increased stake in Mozal and, at the same time, as I mentioned earlier, the changes we've done around securing MRN allows us potentially to extend the bauxite mine life by another 20 years, which really gives us an integrated value chain in one region from Worsley to Hillside to Mozal, but also in the Americas region now with what we have in Brazil. But on top of the existing projects we actually have, if you sort of talk about our future growth, so we've got the short-term pickup in the next couple of years. But beyond that, we've also got a large pipeline of projects underway now. We expect those development options to be predominantly underpinned by what we're doing in North America. On this slide here, you can see the Hermosa Taylor deposit is now in the feasibility stage. And we've done a lot of work, which actually looks at what that looks like. And we believe it's a sustainable, low-cost zinc, lead and silver operation. And we do believe zinc is a commodity that is currently misunderstood by the marketplace, and there's plenty of opportunity for upside. We expect the final decision to be made, if you like, on Taylor in 2023. And at the same time, on top of Taylor, we have a second project at Hermosa named Clark. And the Clark project there is in prefeasibility study. We also have a number of exploration targets on the broader land package, where we're looking at Flux and Peake. And Peake, for example, has strong copper signals on the first couple of holes that we've actually drilled there. At the same time, across our portfolio, we have multiple other options underway, including a prefeasibility study stage for the Arctic project, Ambler Metals. We've spoken about the copper oxide project at Sierra Gorda. And on top of that, we actually have a large exploration, if you like, program where we have 25 greenfield partnerships in attractive jurisdictions that are discovering -- targeting discovery of our next generation of base metals mines. Maybe just skipping forward a couple of slides. I'll focus a little bit on our market outlook, but I won't spend too much time on this. If you look at our current commodity mix, you'll see that we have a variety of different exposures. And while I won't go into detail, I think it is important to note that, again, the exposure of the group has dramatically shifted, if you like, both geographically but also the type of commodities we actually sell. And we do believe the commodities we have increased our exposure to are structurally aligned to the transition to a low-carbon world. And you really see that, if you like, on the chart on the left-hand side. The other thing that we do believe strongly, which drives our demand for these commodities, is if you look at a 1.5-degree world from 2020 to 2050, you really see the need for these materials. For example, aluminum will benefit from higher intensity of use in electrical vehicles and substitution of fossil fuel-based plastics and packaging. Copper, we all know about the value that, that will drive in terms of EVs, charging infrastructure and renewable energy. But zinc, again, as I mentioned earlier, is one that we think is quite misunderstood. Zinc in itself will be used, again, in -- largely in wind and solar panels but also wind turbines. It protects against corrosion. And we can actually see a tenfold increase in a 1.5-degree scenario world. And zinc, again, for us is an interesting commodity because it actually has a lot of drop-off in terms of current supply. And you also need almost 3 Taylor deposits to be developed every year to try and meet that gap. And in manganese, we believe there's potential there to displace cobalt in lithium-ion batteries, which is much more affordable and readily available. So when you look at each of these materials, you can see why we identified the need to shift that portfolio when we actually were created in 2015 and why we're excited about the future. So look, I hope from what we've spoken about briefly today, before we hand over to James to go through some Q&A, who we are today is very different from what we started in 2015. And obviously, we couldn't have got to that point without the hard work of our people whose passion, expertise and hard work cannot be overstated. They've made a huge difference to our business and where we're going, and the business has undergone a major transition. It's almost to the degree that when you look at the company now, it's very hard to recognize it compared to what we started with in 2015. But we are now a truly global and diversified producer of the metals that are critical to a low carbon future. We continue to run the base business really well. But at the same time, we continue to actually benefit from the tailwinds of our favorable commodity mix, and recent portfolio improvements have supported record earnings and shareholder returns. While the past 12 months has been some of the most exciting times in the history of our company, we believe there's a lot more, if you like, as we look forward, particularly when you think about the opportunities that exist in our current operations, the development options we have in the short to medium term and, longer term, the progress we have made on the exploration space. We think it actually positions us in a position where the value proposition from when we started in 2015 is very different than what it is today. Maybe, James, we can sort of go into Q&A.

Thanks, Graham. I guess first question is South32 has pivoted quite strongly towards base metals, as you said in your presentation, nearly 75% of our earnings at the moment. I guess my first question is, is manganese still core for South32? And maybe can you please comment on why the manganese price is so strong at the moment? Is that due to rail bottlenecks in South Africa?

Yes. So I guess manganese is an interesting commodity because it's probably one that's not that well understood by the general investment community because it is relatively opaque. I think manganese has some advantages over met coal and steel. When you recycle steel, you have to add back in manganese. So it's very different, if you like, compared to steel -- the other steelmaking materials. I think what you have seen in terms of supporting price over the last probably 12 to 18 months is a shift in China with rising energy costs but also, if you like, some of the environmental regulations. You're seeing much more of a focus on using higher-grade materials. So people talk a lot about the stockpiles, if you like, that exist in China that sit on the ground. But if you break those stockpiles into the low, the mid and the high grade, what you really see is that high-grade turns over really quickly, the low and the mid-grade, not so quickly. So from our perspective, particularly with GEMCO, GEMCO is the best asset in the industry, lowest cost, closest to the customer, best quality. From our perspective, it generates strong returns. We believe there's some options to extend the life of GEMCO through the Southern leases and some of the other work we're doing, and it's been a strong earner for us. But I think the other thing that's slowly developing is there is a real push, again, in the battery technology to replace cobalt. And manganese, if you think about what it brings in terms of energy density value, it's certainly moving up, if you like, that position very quickly. And that's something we're looking at not only obviously in the Americas but also what we have in our existing operations. South Africa is more of an interesting one because the Kalahari is the biggest basin in the world. It does provide some structure to the industry because while the mining costs are relatively cheap at the moment, the real cost is around logistics to actually get it out of the country and get it to the end customer. From our perspective, we're all about trying to secure more rail access, but we have probably one of the only high-grade mines that exist South Africa with vessels. And we have the ability to double capacity out of that if we choose to do so. So far at the moment, it certainly fits in our portfolio.

Okay. Sierra Gorda was a good transaction for South32. It was value accretive on our estimates. How has Sierra Gorda performed since you took over in February?

Yes. Maybe taking a step back, I guess, like everyone, we've been interested in finding copper. The challenge is finding copper at a price that is attractive. I'll be perfectly honest, the first time that the business development team brought Sierra Gorda to the table, my approach is probably, this has been an asset that had really tough time in terms of project execution. It had a really tough time in terms of commissioning, and you're probably going to see that as other large copper projects get executed and go into commissioning over the next 12 to 18 months. I guess what sort of did convince us is every time we pulled a layer off the onion, we found more upside. For the last 2 years, we've actually had record production out of the processing facility but also at the mine. And I guess what impressed us to sort of make the initial decision to actually proceed with that is if you spend time with the team on the ground, actually, we have a very good management team that have made real changes to the process flows and some of, if you like, the -- how they actually set up different parts of the facilities to actually make sustainable changes. So since we've acquired it, we've actually been impressed with how they're progressing with the debottlenecking project. But now they're also talking about the fourth line that we believe can give another big bump up in production, and that's going through a prefeasibility stage study. So I think there's a lot more upside, if you like, on Sierra Gorda than we've actually seen to date. Working with our joint venture partners, KGHM has been great. They pretty much included us from day 1, even before the deal was finalized.

Okay. Any questions from the audience? Wait for the microphone, please.

How are you seeing the permitting process for the mines, for Hermosa and for Ambler here in the U.S.? How long are you budgeting for those?

Yes. So maybe if we sort of break them into 2 separate issues because they are quite different. Particularly in Arizona, there's a lot of noise around Hudbay's experience with Rosemont. There's a lot of noise around resolution. What we're doing in Hermosa is very different. It's an underground mine open stoping. All the infrastructure, bar one piece I'll come back to, is actually on patented land that doesn't need federal approval. We have no subsidence issues. We have no endangered species, and we're not positioned on a strategic highway. And if you think about some of the areas of square disturbance, we're talking about 100th of what they are. What we're looking to do, the only infrastructure that will actually be on federal land will be the second stage of our tailing facilities. So maybe think about 2 or 3 field-sized football fields. So we think that is a very different permitting process. And if you take something like Pinto Valley, I think that has got their most recent one approved on federal land, and they took 3.5 years. I think at Taylor, our bigger constraint is actually dewatering, if you like, and that's probably on the critical path. When you come to Arctic, it's slightly different. Artic, the mine itself, was on NANA land. So it's private land that doesn't need federal approvals. It's more about the road that will connect the district, the Ambler district, to the Dalton Highway. It's about 340 kilometers. That was probably saying that they got pushed through very quickly under the Trump administration that's sort of been wound back a little bit now. We don't see that as a material issue. We think it's going to take a bit more time to work through the process. But generally, some of the key stakeholders who are going to be involved and using, if you like, that road have being very supportive to date in that process. We just think there's some more work to be done in consultation. I think the bigger issue for us in the Ambler district is finding another VMS-style deposit like Arctic. And I think that will more support the development of the region. We also have our own project out there called Roosevelt that is also on the project, and we're looking for a similar style deposit like Artic.

Good. One in the back.

Thanks for the presentation, Graham. The -- your dividend payouts are quite high, like 83% of underlying earnings, which seems almost inconsistent with the growth story that you're telling. Like normally, companies that are trying to grow the way you're growing aren't paying huge dividends. So is it that you're not deploying capital fast enough or it's taken a while to assemble these growth options and now the payout is going to go down? How should we think about that?

So the way I think about it, James, will be the 40% is a given because we say that's actually a minimum. I think one of the constructs we do have is we talk about a payout ratio as underlying earnings, not about cash flow. So because of some of the historical cost base, we do have relatively high D&A. So that provides a little bit of a buffer. But in saying that, I do think as we look going forward, we do have more opportunities to actually deploy capital in the business to create future growth. So that's not something we've had to deal with in the past. But I think the flip side is while you've got your ordinary dividend, we absolutely believe in the constant tension of our market buyback through capital management. And I think comparing the returns on that versus all our growth projects is a really good discipline for management, and we continue to drive that behavior. For me, you get real bang your buck out of our capital management if you're consistent. That will ebb and flow a little bit, depending on the share price. But you should expect us to be in the market consistently doing on-market buybacks. If we don't fulfill, if you like, all the requirements on that, then we look at things like special dividends.

Very good. What's the limiting factor on growth today? Is it internal capacity to execute projects or is it permitting? It doesn't sound like it's capital.

So I would have said, look, it's -- while the portfolio has changed a lot, if you like, in the last 7 years, particularly the last 12 months, the work to make that change has probably taken about 4 or 5 years. So that's finding the options like Taylor and Clark at Hermosa, buying Sierra Gorda, but it's also been about divesting things like South Africa Energy Coal that was low returning but hugely capital intensive. So I think we're recycling capital into different places with higher returns. And I think the limiting factor in the past has been the cupboard was bare. Now we've actually got a cupboard that has more options. And now we're actually looking to high grade those options. And I think that's a good place to be compared to where we were.

Thank you. I think we're out of time. So please join me in thanking Graham for his presentation. Thank you.