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Edited Transcript of S32.AX earnings conference call or presentation 21-Aug-19 10:30pm GMT

Full Year 2019 South32 Ltd Earnings Presentation

PERTH Sep 7, 2019 (Thomson StreetEvents) -- Edited Transcript of South32 Ltd earnings conference call or presentation Wednesday, August 21, 2019 at 10:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Katie Tovich

South32 Limited - CFO

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Presentation

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Katie Tovich, South32 Limited - CFO [1]

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Hello, everyone. As always, I'd draw your attention to the important notices. Now let's go to the overview, where our strong operating results continued returns to shareholders and investment in our portfolio sees us well-placed entering FY '20. Underlying EBITDA declined by 13% to $2.2 billion, while free cash flow was $1 billion, as the benefits of stronger alumina process, weaker producer currencies and cost-reduction initiatives across labor, energy and materials usage were more than offset by lower aluminum and thermal coal prices. Underlying earnings decreased by 25% to $992 million while underlying earnings per share decreased by a lesser 23%, as we continued to benefit from our ongoing share buyback. In accordance with our dividend policy, our Board resolved to pay $140 million ordinary dividend, increasing total returns to $762 million in respect of the period. Given our strong financial position with our 30 June net cash balance of $504 million, and demonstrating the disciplined approach we're taking to our capital management program, and our confidence in the outlook for the business, the Board has expanded our program by $250 million to $1.25 billion, extending the period of completion to September 2020.

Subsequent to the end of the period, we entered into an exclusive negotiation with Seriti Resources, as we work towards finalization of their offer to acquire our South Africa Energy Coal business. After considering the value of their offer and the market outlook for energy coal, we recognized an after-tax impairment charge of $578 million in the period, the effect of which reduced our statutory profit after tax by 71% to $389 million, a strong operating performance with group production volumes increasing 3%, weaker producer currencies and the implementation of a number of initiatives to mitigate inflation and protect our margins ensured we achieved a 34% operating margin, despite generally lower commodity prices.

At an operational level, we increased production at Illawarra to 6.6 million tonnes, exceeding our guidance. At Worsley, we opportunistically sold stockpiled hydrate at alumina equivalent rates, offsetting the impact of additional costs incurred to sustainably return to nameplate capacity.

We delivered 5.5 million tonnes of manganese ore into a strong market, with SA manganese exceeding guidance and Australia Manganese operating the PCO2 circuit at approximately 120% of its designed capacity. We are also continuing to progress our review of our manganese alloy smelters as changes in market dynamics have reduced the attractiveness of our exposure. Notwithstanding a production record at Hillside and strong performance at Mozal, lower LME aluminum prices, higher alumina prices and still elevated pitch and coke prices did, however, place great pressure on our aluminum smelters. Margins at SA Coal also came under pressure as the dragline outage at Klipspruit, reduced export volumes, and we incurred additional mining costs for concurrent rehabilitation. The dragline was recommissioned in the March quarter, with production increasing in the second half. Throughout our business, we continued to chase ways to mitigate inflationary pressure and protect margins.

For instance, improved longwall productivity at Illawarra and opportunistic volumes at our manganese operations delivered more than $100 million of incremental margin. We also renegotiated an energy contract at Cannington, delivering annual savings of $6 million, and optimized our energy usage at Illawarra, achieving a further $15 million saving.

At Hillside, we completed a restructure of the workforce, while at Illawarra, we increased workforce flexibility through the renegotiation of all of our enterprise agreements. These efforts set us up well for the future and are expected to result in lower unit costs for the majority of our operations in FY '20.

In November 2017, we announced our intention to manage South Africa Energy Coal as a stand-alone business. Our vision was that the business becomes sustainable, black-owned and operated, consistent with South Africa's transformation agenda. Following our comprehensive and competitive process, we have entered into exclusive negotiations with Seriti Resources and are working towards finalizing their offer, which will include a transfer of all of the assets and liabilities of the SA Coal business. A successful divestment will mark an important milestone for South32, substantially reducing our capital intensity, strengthening our balance sheet and improving the group's ROIC and operating margins. Together, with the announcement of exclusive negotiations, we have recognized an after-tax impairment in our FY '19 accounts of $578 million. This impairment writes off historic investment in PP&E while also derecognizing deferred tax assets, following the investment of $377 million in the business across FY '18 and FY '19 to improve its competitiveness. While the offer from Seriti is indicative, it implies our FY '20 capital expenditure and cash working profit is expected to be mostly offset by the transaction consideration with no further cash outflows beyond the normal course of business. All assets and liabilities transfer on completion, achieving what is effectively a net neutral exit. Markets were challenged for the majority of our commodity suite during the period, delivering a net $333 million reduction to our revenue line. Smelter raw material markets also remained elevated in the first half. Before turning back in the second half of the year, these, together with increased royalty payments at Illawarra, contributed to price-linked costs, reducing underlying EBIT by $94 million. In contrast to recent periods, a stronger U.S. dollar provided meaningful relief, delivering a $327 million benefit, while general inflation, primarily in South Africa, reduced underlying EBIT by $129 million. Given the magnitude of recovery underway at Illawarra and the dragline incident at SA Coal, we have broken down the volume and cost impacts for greater clarity. In doing so, you can see that these 2 operations dominate the volume-related variance with the increasing controllable costs at Illawarra, largely a function of improvements in longwall performance. Elsewhere, at Worsley, although, we benefited from higher volumes, we incurred a $111 million increase in controllable costs, as we drew down inventories and committed additional funds to improve calciner and general plant performance. This supports a push towards a sustainable return to nameplate capacity ahead of debottlenecking activities. At SA manganese, we continue to take advantage of strong market conditions, as productivity improvements at vessels delivered an increase in premium material, contributing to a $42 million volume benefit to underlying EBIT.

The $33 million increase in controllable costs reflects increased workforce activity and the use of higher-cost trucking to support the additional volumes and improved margins. The large majority of the $98 million increase in other operations controllable costs reflects technology expenditure, inventory movements at Hillside and additional consumable and pot realigning costs at Mozal. Bringing this together, the top-right chart shows the $234 million sales volume benefit, which essentially accounted for by Illawarra and SA Coal, with movements for other operations offsetting each other. This volume benefit partially offsets the $354 million increase in controllable costs with the remainder explained by additional funds committed to sustainably return Worsley to nameplate capacity. Now underlying net finance cost of $118 million reflects the unwind of the discount applied for rehab and finance lease interest primarily at Worsley.

The group's underlying tax expense of $330 million equates to an underlying effective tax rate of 38%. The significant increase in our effective tax rate reflects the change in our geographic earnings mix, differing country tax rates, the disproportionate effect of intergroup agreements and other permanent differences.

Looking ahead, we expect this rate to remain at elevated levels in FY '20, if compressed margins at our African aluminum operations persist. The derecognition of tax assets in SA Coal will further increase the rate if it records losses in FY '20. Here, our cost analysis shows that a stronger U.S. dollar more than offset higher price-linked costs, royalties and inflation. Smelter raw materials, including pitch and coke contributed $35 million to the price-linked cost increase, with the impact weighted to the first half. In this regard, Hillside also received a $19 million benefit in electricity costs due to the LME aluminum price linkage. Lower-costed prices primarily at Worsley delivered a further $33 million benefit, while higher diesel and fuel prices at our upstream operations contributed to a $34 million cost increase. At the group level, in FY '20, we expect corporate costs of $19 million, as we increased functional support for our development projects and invest in technology to support our operations. More broadly, we expect to invest $30 million in greenfield exploration in FY '20, with another $25 million of exploration to be capitalized as we further increase our knowledge of the Taylor deposit and the broader Hermosa land package. For our 7 operations, where unit cost guidance is provided, costs were below guidance for 3 operations, above guidance for 3, and in line for Australia Manganese. Focusing on the operations not spoken to in the performance analysis slide, at Cannington and Cerro Matoso, higher volumes drove lower costs with the latter also benefiting from energy procurement optimizations. At Brazil Alumina, unit costs were higher as boiler performance impacted volumes. Further, bauxite costs were elevated as we secured additional third-party material and the price applied by MRN was reset in accordance with its linkage to the alumina index and the LME aluminum price. Considering the broader outlook for costs, the chart at the bottom of this slide shows that raw material cost pressure for our aluminum smelters eased in the second half of FY '19. As you would expect, we're focusing on what we can control to ensure our smelters are resilient in the current price environment. We have successfully completed a substantial workforce restructure at Hillside and continue to roll out the AP3XLE energy efficiency project at Mozal. Elsewhere, FY '20 operating cost guidance is either lower or in line year-on-year, as we expect to benefit from a stronger U.S. dollar, a reduction in price-linked costs and continued efforts to mitigate inflation and protect margins across our portfolio.

At Illawarra, although we see higher costs year-on-year, this reflects the impact on FY '19 unit costs. Of the sale of a portion of a mining lease in the Appin Area, which more than offset higher volumes and a reduction in maintenance spend in FY '20. At Worsley, we expect unit costs to benefit from higher production and a reduction in caustic soda prices and lower energy costs following the renegotiation of legacy gas contracts. Although guidance is not provided for Brazil Alumina, they are also expected to benefit from lower caustic soda prices and higher production volumes as we begin to see improvements to steam generation from package boilers installed in the June 2019 quarter. At SA Coal, costs are expected to be up to 7% lower as we reduce contractor activity at the WMC and benefit from a weaker South African rand. We have provided a range for production and unit cost guidance for SA Coal. This reflects our intention to be flexible in order to maximize margins in response to market conditions. In our manganese business, costs at GEMCO are expected to be flat. As we further improve the equipment productivity and run the PCO2 circuit above nameplate capacity, offsetting and expected increase in the strip ratio. While at our South Africa Manganese operation, a weaker rand and lower price-linked royalties are expected to deliver a 9% reduction in unit cost. As we have done in prior years, we will continue to monitor market demand and respond accordingly. At Cannington, costs are expected to be lower as mill throughput increases and haulage costs reduce following the prior period impact of floods in North Queensland. Finally, at Cerro Matoso, we expect the unit cost to be flat, despite an extended outage of one of the furnaces in the June 2020 quarter that will contribute to a 13% production decline, offset in part by lower price-linked royalties and the optimization of our energy usage and procurement.

Turning to CapEx. Putting SA Coal to the side for a moment. The majority of the expected 18% increase in sustaining capital in FY '20 relates to infrastructure improvements to support the return to a 3 longwall configuration at Illawarra Metallurgical Coal. Higher major capital spend reflects increased activity at Hermosa, where we expect to spend $109 million, primarily directed towards on-site infrastructure and to advanced project studies. We also expect to advanced studies for the Dendrobium next to main project, which has the potential to extend the mine life at Dendrobium to FY '36, subject to receipt of the necessary regulatory approvals. SA Coal accounted for 17% of the group's sustaining capital in FY '19, and we expect to continue to invest during FY '20, as we advance the Klipspruit extension project. Looking forward, if we remove the contribution of SA Coal, the group's sustaining capital is forecast to range between $450 million and $515 million on an annual basis. During the period, we generated $1 billion of free cash flow, including net distributions from our manganese business of $458 million. This included a $129 million increase in working capital, as we established inventory at Illawarra and Cannington following improved performance. After accounting for shareholder dividends and the $281 million we directed to our own market share buyback, the group finished the year with a closing net cash balance of $504 million. Excluding the leases adjustment, our 31 July net cash balance increased to $644 million, as working capital partially unwound.

Our strong financial position and disciplined approach to capital management has allowed our Board to declare a $140 million final dividend and expand our capital management program by $250 million to $1.25 billion. After accounting for the $140 million dividend payment in October, and the remaining $264 million committed to our capital management program, there remains additional capacity set aside to potentially increase our interest in the Upper Kobuk Mineral Projects. We can earn a 50% interest in the high-grade Arctic and large Bornite copper resources by committing $150 million to a 50-50 joint venture with Trilogy Metals by 31 January 2020. Turning to our capital management program. Looking back over the last year, you can see the slower rate of progress in the period, dictated by market liquidity and our focus on value, rather than execution speed. To 30 June, we have bought back and canceled $747 million worth of shares, or approximately 6% of issued capital. With an average purchase price of AUD 3.16 per share compared with a market volume weighted average price of AUD 3.36 for the same period. This reduction in share capital delivers a lasting increase in dividends per share, given an intention to return a minimum 40% of underlying earnings to shareholders in each 6-month period. Finishing with our capital management framework, which remains unchanged, total returns in respect of the period of $762 million equate to almost 80% of our free cash flow, or 8% of our market capitalization, despite our acquisition activity. This demonstrates the balance in our approach. Looking ahead, we will continue to focus our efforts on improving return on invested capital and prioritizing a strong balance sheet to ensure we remain in control through economic cycles. Having established a strong track record, we will continue to assess our future development options against other uses for excess cash, including further returns to shareholders to ensure we remain focused on maximizing value for all of our stakeholders. Thank you.