South32 Limited (S32) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to South32 Half Year Financial Results and Outlook Investor and Analyst Call. [Operator Instructions] I would now like to hand the conference over to Mr. Graham Kerr, CEO. Please go ahead.

Good morning, good afternoon, everyone, depending on where you are, and thanks for joining us today. On the call with me is our Chief Financial Officer, Sandy Sibenaler our Chief Operating Officers, Jason Economidis and Noel Pillay; and our President of the Hermosa project, Pat Risner. I'll give a short summary before handing back to the operator for questions. I'd like to begin with our most important commitment that our people go home safe and well every day. We continue to embed our safety guarantee across our business to enhance our safety culture and fundamentally shift our safety performance, quite simply nothing is more important. Today, we've announced a major milestone for our business. The final investment approval to develop the Taylor zinc-lead-silver deposit the first phase of our regional scale Hermosa project in Arizona, since the merger, we have worked to improve and reshape our portfolio for a low-carbon future. We divested South Africa Energy Coal, SA manganese alloys, invested to grow our production of low-carbon aluminum added copper [ three year ] acquisition of Sierra Gorda and embedded high-quality options to compete for capital. Executing the development of Taylor is an important next step in our strategy that will further improve our portfolio by increasing our production of critical metals needed for the global energy transition. We expect Taylor will lift group margins due to its first quartile cost position and establish a significant shared infrastructure that will unlock value for future growth phases at Hermosa. These include Clark, our battery-grade manganese development option and exploration prospects in our highly prospective land package, which has already turned high-grade copper and zinc results. The combination of Taylor Clark and the regional land package gives us a platform Hermosa to produce critical commodities from multiple different deposits for decades to come. The Taylor feasibility state confirms the this potential as one of the world's largest, lowest-cost producers of zinc, a critical commodity for the global energy transition that we expect will deliver value for our shareholders for decades to come. We expect strong demand Market fundamentals for zinc with global demand growth is expected to outpace production by about 3 million tonnes to 2031. An industry challenge a similar magnitude to copper. We expect higher incentive prices for zinc as Taylor ramps up to nameplate capacity for FY '30. Taylor has been designed to minimize environmental impact. We have applied next-generation mine design principles due to the automation and technology to drive efficiencies and lower operational greenhouse gas emissions, in line with our goal of Net zero greenhouse gas emissions for 2050. The feasibility study confirms Taylor's position as a large-scale, highly efficient underground mine with conventional processing in the first quartile of the industry's cost curve. The initial operating life has been extended from 22 years to 28 through additional drilling and geological modeling for the first time or reserve underpinning the first 19 years of the operating life. We expect to invest USD 2.16 billion in direct and indirect capital expenditures with the first production in the second half of FY '27, establishing a modern long-life operation. Hermosa will benefit from being the first mining project added to the U.S. government's FAST-41 permitting process, which is expected to deliver an efficient and transparent process of federal permitting to Taylor and Clark. The construction of Taylor is expected to be funded primarily by the group's operating cash flow, any required external funding will be consistent with that commitment to a strong balance sheet and investment-grade credit rating. Turning now to our half year financial results. Macroeconomic conditions created headwinds for our commodities during the half. We delivered group underlying EBITDA of USD 708 million and an operating margin of 19.0%. Operational highlights included a record half year aluminum output and sequentially higher zinc and nickel production in the December quarter. We continued our rigorous focus on cost during the period and completed a group-wide review that supported operating cost efficiencies and reduced expenditure. This focus supports our [indiscernible] operating unit cost guidance being lower or have unchanged across the majority of our operations and a 6% reduction in FY '24 operational and capital expenditure guidance. We remain focused on driving operational performance and cost efficiencies across our business. We continue to prioritize a strong balance sheet and investment-grade credit rating through all price cycles. As part of this focus and to maintain our balance sheet position, we have taken the decision to cancel our on-market buyback, which was due by 1st of March 2024. Consistent with our unchanged capital management framework, and in the context of our financial position, we will continue to assess the opportunity to return excess cash to shareholders in the most efficient and value-accretive manner. Despite experiencing some challenges during the period, we are expecting a strong second half. We are well positioned to capture higher margins off the back of our expected 7% production uplift and ongoing focus on cost management coupled with strengthening market conditions of key commodities to start the calendar year. We continue to invest to unlock value from our high-quality operations and growth opportunities in commodities critical for a low carbon in the future. In closing, I'd like negating across the world with their hard-working commitment, looking ahead, we are committed to safely delivering improved operational performance and cost efficiency across our business, and we are unlocking value in our high-quality operations and growth options to further improve our portfolio and strengthen our exposure to the increasing commodity demand required for the global energy transition. Thank you. I'll now hand back to the operator for questions.

[Operator Instructions] Your first question comes from Tim Clark with SBG Securities.

I've just got a couple of questions, please. You've done a formal review and just reading through the cost guidance changes. Some of them look like caustic Southern and various other sort of kind of input cost changes. I wonder if you could speak to the outcome of that cost review, either from a cost or a CapEx side. What's changed in the organization? Where have you rationalized, where have you taken projects out or made sort of active decisions beyond just sort of the sort of following of normal input cost material. That's my first question. I'll come back on the second one.

Okay. Sandy, probably one for you?

Sure. So when we think about costs, obviously, we're looking at both efficiently opportunities there and then obviously targeting kind of better contractual and commercial outcomes as well. And the target for those elements is obviously very different across the range is our business. But for example, we look at improved kind of efficiency in the way we look at our maintenance program or the types of maintenance like I said, maintenance programs run in different operations. So I think they're probably some of the bigger elements are focused on cost. Obviously, we also get any vacant role we've looked at kind of discretionary expenditure components as well. So a fairly comprehensive view of cost across all of the controllable elements. And then on top of that, we've got the as you noted the market input factors that are driving some of the costs as well. On the CapEx front, that's really being focused on efficiency of capital. So where can we combine projects and achieve better outcomes and also looking at different ways to contract that work or phase that work. Some of the work also want to be at more detail at didn't return at the same levels because of the CapEx escalation we have seen across our industry broadly. And as a result, we've put on those projects into recycles.

Yes. It just sounds like a sort of active cost view across the whole organization rather than any very specific things. The second one, just on Mozal. I was very worried when I sort of saw that Bloomberg article a couple of weeks ago about the 2026 date. And I was nervous coming into this result that there could be an impairment even or a risk that, that operation is facing significant risk. Wonder if you could just give us some sense of your comfort levels because '26 is not far away. It's just around the corner, right?

No, that's true. It's not far away. It's probably Tim, something that's been out there for a period of time now. So it's not like we had -- and we've talked to the market about before, and it's not like we're actually all of a sudden dealing with this today. So we have been in discussions for a period of time and have a dedicated team. Nolan, myself even in December, we were with the government and the President of Mozambique, and part of that work is putting together, if you like, a working group from our side and a number of key advisers and minutes from his side to continue to actually pass this track this through. If you talk about the economic benefits of Mozal or maybe just outline some of the form.

Yes, very much, so Graham the economic benefits at the start, Mozal contributes to just under 4% to the GDP of Mozambique and it employs some 5,400 employees. And of course, there's a knock-on impact across the industry with much more than that. And so a significant player in the Mozambique economy terms and that's the message we're trying to -- and on that basis that we're engaging the government of Mozambique of related stakeholders on ho to co-create solution that can preserve that. So as Graham outlined, there's an intimate [indiscernible] that's been put together now, to work this or to fast track if the works like Graham's shared has been ongoing now for the past few years. But again, like you said, 2026 is not far away. And so we want to push that to closure as soon as we can. So that work is underway. And I think by the end of this FY will be -- we have a clearer direction in which way that's going.

Okay. That's helpful. And then just my last question. I would imagine that when you took the tailored to the Board, that you ran a scenario sort of almost assuming a spot price scenario discount rate of whatever it is, 10%, something like that. So just ran a fairly benign scenario through. I wonder if you could speak through whether you -- because I would imagine that scenario is not very attractive. So it's obviously a difficult kind of tension point. I wonder if you could just speak through your scenario, thoughts around value at Taylor.

Yes. Certainly, we can do, Tim. And I'm not disputing that back and we'll come back to the sensitivities. But I do think Zinc is one of the commodities where a number of people because of the size of the market, don't do the same equivalent work that you see in the copper space. So when we talk about our base case, if you like, that we use, it is not dissimilar from a number of our large competitors in this space that have publicly put numbers out there previously, one large North American producer and another one a large trading house, they certainly flight numbers out there that are very similar in the time frame. Wood Mackenzie when they did a similar kind of inducement methodology come up a similar price. And then a fair few of the analysts have do a fair bit of detailed work on Zinc ore have a very similar price. Now in saying that price like most projects has a very large sensitivity. We do run a different scenarios on a number of variables and obviously, price is one of those. We have run sensitivity for our board, obviously, on things like consensus pricing, which is lower than ours. If you look at the average of consenting pricing, we've also run our own low case. We also run our own high case in our mid case. So we test a variety of different scenarios to actually test the robustness. I think the critical one for me around Zinc is obviously, at the moment, the spot we don't think is actually a reflection of where we see the market actually being long term. And you can argue for a number of different commodities, obviously, you get spot prices at the time that aren't really where you expect things to be. Now in saying that when we think about this investment as well, and I made this comment on the call earlier this morning, so apologies if you heard it already or people have. What do you really look for a resource project. You look for something that has a long life you look for something that has a low position on the cost curve. You look for something that has multiple options to grow, if you like, in the basin over many decades. And ideally, you wanted in a safe jurisdiction. If you think about the Hermosa basin play, that ticks all the boxes for us. Now there is no doubt that the first piece of this project is actually when I say this project tailor, it is picking up substantial capital around things like infrastructure, such as water, power, dewatering, tailings facilities, road [ wattages ] et cetera. In fact, it's roughly around 27% of the capital that's been spent since the pre feasibility is around joint infrastructure that will allow us to look at something like Clark. And Clark, for example, has a range of uncertain or maybe let's talk about the optionality we have in the basin. So I'll start with saying that, look, first off, when you look at Taylor, Taylor were about 31% more metal between the preseason, the feasibility study. That sort of takes a mine life at about 28 years. Taylor itself is still open at depth and it's still open in multiple directions. On top of that, we've obviously got the class deposit that sits at the top that's the manganese project now that we'll just finish halfway through the prefeas we're looking to actually do the decline and a bulk sample to give enough material to the 19 plus different people we have MOU/NDAs with, just try and develop that product. And Clark could actually be our most valuable thing on that. property or it could actually be worth nothing depending on how that actually pans out. Peak is where we've been having some great intercepts, if you like recently when we've been doing some work there. Peak itself at the moment, we sort of gave you a sense of what the resource target could look like. What we're ultimately hoping to see is as we do more exploration work that peak actually goes all the way from where it is now. Enjoying back up to the bottom of tailored deep, where we actually had high copper content already in that concentrate. So that's another piece of optionality there. The other one is 5 kilometers away, we just actually started doing some work on what's called the Flux prospect. And Flux has really built off the back of very similar geological ground host conditions as Taylor and it also was build [ propanol ] shallow mine. It is actually much shallow than basically Taylor. The first hole was around 250 meters and we've hit strong mineralization in that and the next couple are looking good as well. So I think this is the point we're trying to make sometimes in, yes, they feel like a 12% IRR sensitivity to price but I think it does set you up for many decades to basically add all these options in. Unfortunately, on both an NPV and an IRR perspective, that doesn't necessarily translate well out in the model because anything beyond 15 years probably gives very little value. Now the market itself on zinc, just to go back to your spot question, look, it is not -- we're not really obviously seeing strong demand out of Europe or China at the moment. But in saying that, we expect that to continue to shift. The reality is over the last 10 years, the average ink rate is probably half and the only real major discovery has been Taylor. And as we all know, bringing new projects to the market is getting harder and harder. Over the last probably 5 to 10 years, you've seen elevated prices for zinc and the world's largest producer, which is China, has been failed to actually bring new tonnes of the market due to their own grade degradation and increasing, if you like, environmental regulation, which is very similar to what we've seen in the manganese market that occurred probably about 5 years ago. So when if you think about short term and I'll say, short-term here out 2031 and I say short term because if you think about the life of the optionality, it's many decades beyond this, we would actually see that there's going to be about a 3 million tonne shortage to 2031 when you compare supply versus demand. And if you think about the demand, so it's not like you can go from galvanized steel to aluminum, the cost jump is way too big. So really, zinc is the commodity to go through in this space. And I think what you expect to see here, if you're going to try and bridge that graph between now and 2031, you actually need about 3 Taylor sized projects to actually be developed, which is really hard to see that occurring. No doubt, over the last 6 months, Zinc price has been tough. I think that is a reflection of power costs, other things going on in Europe that we don't think is sustainable. China is probably the biggest one to watch so obviously, on the actual supply side. Does that sort of help you some color on, Tim?

That's very helpful. It will help. It will help us a lot to work through that.

Your next question comes from Glyn Lawcock with Barrenjoey.

Well, you never know. Maybe I'll try and be a bit more direct the second time around. Look, you said in your opening preamble, you expect a strong second half. Can you maybe put some meat on that bone? I mean is the business now generating positive operating cash flow and positive free cash flow. And given what you've said about 250 headwind working capital in the first half, and CapEx is going to be $100 million lower in the second half relative to the first, and costs are down, volumes up. Does that mean net debt, all else being equal, if prices stay where they are, net debt should fall over the half?

Yes, I'll take that one, Glyn. Just to capture the key element, I think, some of which you've already noted there. So we do expect a 7% uplift in volumes in the second half. We do expect the working capital normalized ideally in the March quarter, although in terms of our [indiscernible] in May rolled into the June quarter, and we have already seen those volumes being cleared out the Richards Bay Port. We do relevantly held our cost guidance or reduced across the majority of our operations. So we're comfortable with where we're at a cost front. Capital, as you note, we've seen a 6% reduction with the kind of prioritization and deferral of noncritical projects where we've completed. So $100 million there. And look at our view of commodity prices do hold where they are, then cash generation will be stronger in the second half, and that would come a reduction in net debt.

So are you -- as we sit here today, then your positive free cash flow as a business?

We're very comfortable in the second half, but based on these fundamentals we will be free cash flow positive in the second half.

Okay. And then maybe just, Graham, turning back to Hermosa in today. Just -- Clark, I think can you remind us what you've said previously about what Clark could look like and the value it could bring. I think you've quantified it in the past.

I think in the past, I've talked about a range of a little as $0 or up to $2 billion depending on which manganese case you believe pans out. So one of the challenges at the moment is, obviously, it's about that shift battery technology, both in the LSP type of battery but also in the NCM622. So you see a shift where if you take the NCM battery, for example, you would actually see the manganese content significantly actually shift compared to where you are today. You go open virtually negligible amount to in a position where you're looking at an amount where it's more likely to be around 69% versus 17% today. And the LFP battery, if you look at what's going on in China now, they're doing the LMFP battery which actually has a manganese content of 65%, which actually had the 0 content in an LFP battery today. What that means when you think about demand, it's actually obviously a broad range of what that actually looks like. So what we have said in the past and our position hasn't really shifted on this one, so I'll just run through that again. If you look at the EV component what we are saying when it comes to batteries, you could actually see a market that could be -- if you think about long term, how it could have been, it could be as small as the demand of 230,000 tonnes or it could be as large as 1.8 million tonnes. What we're actually doing at the moment, keep in mind that Taylor covers a fair bit of these costs. We're also in the position, for example, as we do work on the decline and the bulk sample and that's designed to get enough material to work with the 19-ish customers we've been talking to. Someone in a use, someone NDAs to give them enough material to actually get the final product right, that $60 million that we outlined, we would expect to get some kind of support from the government on that in the form of a grand clean that's probably looking at probably around $20-ish million to help derisk it. And that would come from the department of defense. As we move into the second stage and do a larger, if you like, demonstration plant in that situation, we'd be talking to the Department of Energy to sort of look for a ground there. And Pat to give me a sense of what kind of number would people generally be getting these days in those applications. In terms of.

The minimum of $100 million investment up to as high as $250 million to $300 million, so that range.

So we're probably milking somewhere between $150 million to $200 million, depending on the plan in terms of assistance on that. When to help derisk it as well. But the key for this is different for probably most mining commodities because we're the only manganese deposit that's even close to ready to go in the U.S. We know manganese is a lot of the actual different battery makers as well as the NK users are looking for it. Our job is to try and provide a [indiscernible] like material to lock in a long-term agreement. And that's certainly the objective over the next 6 to 9 months. Now when it comes to those grants, obviously, we don't include any of that including the upside of Clark in this valuation. Likewise, there are some other potential tax credits that come through purely on the Taylor side that we haven't applied for yet until we go into execution. They're probably worth $6-ish million potentially. They're also not included in the valuation yet as well. So all that kind of stuff is some of the optionality we have in -- we've spoken about in the past are not included in the numbers today. Does that help a little bit, Glyn?

Yes. No, that's much better color. I appreciate it.

Your next question comes from Konrad Anuszkiewicz with MBank.

One question from my side regarding Sierra Gorda. If I understand correctly, the final decision will be made in the fourth quarter 2024. And could you give us some color as to the timing of potential new copper production from this sport line. That's the first one. And the second one related to that what's your CapEx estimation for the fourth production line?

Yes. So look, I appreciate that may be worth just touching on Sierra Gorda because one of the other things that's come up as the performance around the gray and in FY '23, because we've been in the shoulders of the ore body as planned, we're hitting probably a grade in '24 or about 0.38% copper where it's about 0.42% in '23. As we get back into the main ore body in '25 you see it sort of get back to that 0.43% and then edge up for probably the bulk of the mine market about 0.46% the other one in the first half of this year in the shoulder area in Phase 6, which is a transition zone we've had quite high clay content and lower moly grade. So we haven't seen the moly recovery you would have seen in the past. We expect that to start returning to more this year. That's the base business when you actually talk about the fourth grinding line, that's designed to sort of lift the throughput up to about 57 million to 58 million tonnes. So that's about roughly in 18%, let's say, 15% to 18% potential increase. The CapEx on this in the past, we've talked about generally a 3-year kind of construction period. We would have actually talked about a capital number historically about $500 million that's probably, yes, closer to the $550 million as we're actually getting close to finalizing the feasibility study to enable the decision to be made, if you like, in the last quarter of our financial year. So while the capital has crept its low capital intensity in the scheme of things. And we're in the process now really of scrubbing the feasibility study within its [indiscernible] review. Does that help on that?

Yes. If I understand you correctly then. So about $500 million additional potential CapEx expansion.

It was $500 million. It's now roughly $550 million. That's a 100% basis, just to be clear, so our share would be 45%.

Yes, obviously. So $550 million is on the 100% basis, right?

Yes.

Okay. And in terms of volumes, what's the accretion from this port point?

So we said about -- If you think about where we are today, it's going to push the number up to 57 to 58 which is roughly 15% to 18% increase.

Sorry, could you repeat, please, on a 100% basis?

100% basis, it was left the actual throughput up to 57 million to 58 million tonnes per annum, which is roughly, let's say, close to the 15% to 18% the number is obviously moving a bit now to finalizing the debottlenecking work as well.

[Operator Instructions] Your next question comes from Mitch Ryan with Jefferies.

First question, just on Clark. Answering Glyn's question, you said the valuation range could be $0 to $2 billion. Obviously, you've only done the final decision on Taylor this morning. But when do you think -- can you give us sort of a time line on studies and when we should sort of start to see some meat on the bone around all the optionality that's been unlocked here and give us a bit of sort of line of sight on some of that?

Yes. Well, I probably -- if I sort of break this into components, I mean, obviously, Flux's early-stage exploration. We're able to talk about our fourth hole on that piece. So that's got a bit of time to go. It's probably about 5 kilometers from the Taylor deposits. So you look to potentially see that through Taylor and share the infrastructure. It does have the advantage the total debt of Taylor is about 1,200, whereas Flux or memory is about 250 impact.

That's all right. Yes.

Yes. If we think about the time line, we did actually talk about the time line for Clark. Clark itself, obviously, I made the point that's about getting enough product and locking in enough customers to basically get buy into this material and then moving to long-term agreements because that will suit us and them because they're going to build large facilities that designed to produce batteries, if you like this kind of material. We would expect that we're going to sort of finalize the decline by H1 FY '26. And once we had material out of that we will actually talk to the customers. We are currently engaged at the moment, the Department of Defense about the grand for the decline in the bulk sample. And I'd like to think that we will have some news flow on that probably in the next 3 to 4 months. And then when we move to the next stage of the demo plant, that's also going through a process now where we're starting to talk the Department of Energy on that. I think the critical piece is getting enough on this bulk sample and actually sort of doing that option to give it to the customers, and then you can look at how you manage it. If this actually work to what we think could be the highest throughput rate, which would be up to about 185,000 tonnes per annum. That would give you a mine life of about 7 years based on the work to date on the prefeasibility study. Pat if you want to add anything to that.

Yes. No, I think the key on timing is we're in the pre-feasibility definition phase now and to move into the feasibility phase, which would be that next phase of study, we really need to run material through the demo plan and get results. So that calendar '26 time frame that Graham talked about is when we're aiming to be running that bulk sample through the demo plant. That's how the field work links to the study work.

I think the other one we did cover off on that probably is I'm very interested in is around the peak deposit and how that's sort of playing out we had a page in the document in our presentation that actually mapped down and then on the page -- it was page -- it is on Page 46 of the presentation pack, and that's probably nice some visual way to represent this. If you have a look at the green blob, that's essentially where we are with peak with the work that we've actually done today. And if we look at the work that's done today, that's identified a potential target of 30 million tonnes that we believe could be there. What we're trying to -- we're trying to prove that basically that green blob connects back to the bottom of Taylor's each in the purple, where we have actually seen in the assays and the work there, higher copper concentrate. And the people who know that part of the world is actually very common to basically have a mine that producers led silver, zinc and copper in that part of the world. So we've actually allowed in the process plant, the ability to add that copper circuit in. I think the critical piece for us is as we do some of that drilling, if peak continues to grow and develop and then we look at opportunities to actually bring the copper circuit quicker and sort of change in mine plant to access it if it stays around a certain size, it will still be attractive but more when we get down to Taylor deep. Taylor could recall of the top of my head, but ballpark what it would cost throughout the additional copper circuit.

Yes, I don't recall that Graham off the top of my head. I'd have to go -- have to go find that.

That time will fine for next week, but it's not huge in the scheme of things because it's an addition to the circuit. It's not like another major piece of configuration. We've certainly allowed the engineering for in the space.

It's tens of millions order magnitude.

So that's just the start of some of the optionality. It was at a whole new area of the Sierra where we're doing some exploration up there at the moment as well and what is it about 14 other targets, I think, roughly that we're looking at across the property. So this is where we talk about this basin player. That's why we like this area. We think there are multiple options there.

Okay. I appreciate your time.

Thank you. There are no further questions at this time. I'll now hand back to Mr. Kerr for closing remarks.

Look, thanks, everyone. Really appreciate you taking the time to dial in today. I know you're all very soon busy. Now we know that the first half of this year, we had a number of different headwinds, which means we weren't generating the cash flow that we'd like to see as part of the group. But we do expect in the second half of the year with tight cost control, refocus on capital, unwinded working capital as well as the $0.07 increase in production as well as some of our key commodities, either keeping high prices like met coal all rebounding like alumina will be generating more cash in the second half of the year. Equally important for us is if you look at where we are now in terms of the portfolio transformation, we do believe that the Hermosa play with Taylor in the first stage, sets us up for a basin player with a large long-life, low-cost assets in a really state jurisdiction that we believe can underwrite cash flow and shareholder returns for many decades to come but really appreciate your support and time today. Thanks, everyone.

That does conclude our conference for today. Thank you for participating. You may now disconnect.