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Edited Transcript of S32.AX earnings conference call or presentation 22-Aug-19 12:00am GMT

Full Year 2019 South32 Ltd Earnings Call (Australian Investors)

PERTH Aug 26, 2019 (Thomson StreetEvents) -- Edited Transcript of South32 Ltd earnings conference call or presentation Thursday, August 22, 2019 at 12:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Graham Kerr

South32 Limited - CEO, MD & Executive Director

* Katie Tovich

South32 Limited - CFO

* Mike Fraser

South32 Limited - COO

* Paul Harvey

South32 Limited - COO

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Conference Call Participants

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* Glyn Lawcock

UBS Investment Bank, Research Division - MD, Head of the Australian Mining & Energy Team and Research Analyst

* John Charles Tumazos

John Tumazos Very Independent Research, LLC - President and CEO

* Lyndon Fagan

JP Morgan Chase & Co, Research Division - Analyst

* Paul Young

Goldman Sachs Group Inc., Research Division - Equity Analyst

* Peter O'Connor

Shaw and Partners Limited, Research Division - Senior Analyst of Metals and Mining

* Rahul Anand

Morgan Stanley, Research Division - Equity Analyst

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Presentation

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Operator [1]

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Thank you for standing by, and welcome to the South32 full year financial results and outlook investor and analyst teleconference. (Operator Instructions) I would now like to hand the conference over to Mr. Graham Kerr, CEO. Please go ahead.

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Graham Kerr, South32 Limited - CEO, MD & Executive Director [2]

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Thank you. Good morning, everyone. Thanks for joining us today for our financial results conference call for the full year ended June 30. My name is Graham Kerr, and I'm the Chief Executive Officer. Joining me here today is our Chief Financial Officer, Katie Tovich; and our Chief Operating Officers, Paul Harvey and Mike Fraser. Mike joins us on the line from Johannesburg. I'll start with an overview of our highlights and business outlook. Then we'll open the call to questions. A pre-recorded webcast of the finance section of our results is available on our website.

Starting with our highlights. A strong operating performance across the majority of our operations saw group production volumes increase by 3% during the year. Some of our key highlights include record production at Hillside Aluminium and strong performance at Mozal Aluminium despite an increase in load-shedding events in FY '19; a 57% increase in volumes at Illawarra Metallurgical Coal as the Appin colliery continues to ramp up towards historical rates; manganese ore production of 5.5 million tonnes with South African Manganese exceeding guidance, and Australian Manganese operating the PC02 circuit at 120% of design capacity as we continued to respond to favorable market conditions.

This strong operating performance contributed to underlying EBITDA of $2.2 billion for an operating margin of 34%, and we finished the year with a net cash balance of $504 million, having generated free cash flow of $1 billion. During the year, we returned $938 million to our shareholders and invested $1.5 billion in our portfolio through the acquisitions of Arizona Mining and a 50% share of Eagle Downs Metallurgical Coal. Our net cash balance increased to $644 million as at the end of July prior to the adoption of AASB 16, the new leases standard, as working capital partially unwound.

Demonstrating our disciplined approach to capital management and positive outlook for the business, today, we announced an increase to our capital management program by $250 million to $1.25 billion, leaving $264 million to be returned by September 2020 in addition to today's $140 million fully-franked dividend to be paid in October.

Moving on now to safety. The most important thing we can do is to make sure that everyone goes home safe and well at the end of their shift. Both our total recordable injury frequency and employee occupational illness rates declined in the year. We also continued to make progress towards our diversity outcomes. We saw year-on-year increases in representation of women on our Board, senior leadership team and overall workforce as well as an improvement in the representation of black people in management roles in our South African operations.

Our approach to climate change is built on 3 focus areas: climate change opportunity, climate resilience and emissions reduction. Each year, we commit to reporting on the progress of this strategy, including the targets and goals we have set ourselves to achieve. In June, we released our tailings storage facilities management report in line with our commitments to the ICMM position statement on preventing catastrophic failure of tailings storage facilities. This outlines our approach to tailings management, and we remain committed to international best practice in the management and disposal of tailings at our operations. We work hard to be responsible stewards of the environment and treat natural resources with care so that they are available for future generations.

Moving on now to our portfolio. We have focused on positioning ourselves for the next phase of growth in demand by creating a pipeline of opportunities to compete for capital. We continue to reshape and improve our portfolio. And during the year, we completed the acquisition of Arizona Mining, acquired a 50% interest in the Eagle Downs Metallurgical Coal project and released a mineral resource for the first time at the Hermosa project's Taylor deposit, which marked a key milestone as we progress one of the most exciting base metal projects in the industry. Work undertaken since the acquisition has significantly increased our confidence in the project and confirmed its ability to deliver strong returns to shareholders over many decades. We have allocated $109 million for advanced project studies and the development of infrastructure of the project as well as $25 million for exploration to increase our knowledge of the resource and the broader land package. We expect to complete our pre-feasibility on the project in the second half of FY '20. We have progressed study work for the Eagle Downs Metallurgical Coal project, and we remain on track for a final investment decision in the first half of FY '21.

An important part of improving our portfolio is assessing our current operations against our view for the future. In November 2017, we announced our intention to manage South Africa Energy Coal as a stand-alone business. Our vision was that a business -- that the business becomes sustainable, black-owned and operated, consistent with South Africa's transformation agenda. Following a comprehensive and competitive process, we have entered into exclusive negotiations with Seriti Resources, and we are working to finalize the offer.

While the divestment substantially reduces our capital intensity, strengthens our balance sheet and will improve the group's ROIC and operating margin, we have recognized an after-tax impairment today of $578 million to write-off our historical investment in PP&E and de-recognize deferred tax assets. As we sit here today, the offer from Seriti means that FY '20 capital expenditure and cash working profit is expected to be broadly offset by the transaction value, with all assets and all liabilities going to them on close.

In our manganese business, changes in market dynamics for manganese alloys have reduced the attractiveness of their exposure, and we continue to review options for our manganese alloy smelters, TEMCO and Metalloys. At this stage, no final decision on the path forward has been taken.

In order to further improve our portfolio, we continue to embed high-quality options in commodities we believe will have strong fundamentals into the future. We have maintained our option for the third and final year with Trilogy Metals for the Upper Kobuk Mineral Projects, retaining the right to earn a 50% interest in the high-grade Arctic polymetallic resource and a large copper target known as Bornite, by committing $150 million to a 50-50 joint venture before the end of January 2020.

We also continue to invest in greenfield exploration. We have a pipeline of partnerships with junior companies and are undertaking exploration in Australia, Europe and the Americas. We plan to spend $30 million in FY '20, targeting projects with a bias to base metals.

Looking ahead, production volumes across the group are expected to rise by a further 3% in FY '20. We expect to see Illawarra Metallurgical Coal return to a 3-longwall configuration during the June 2020 quarter and Worsley Alumina achieve nameplate capacity following further improvement from initiatives targeting calciner performance. We also expect to see lower operating unit costs for the majority of our operations as we benefit from weaker producer currencies, lower raw material costs and our continued efforts to mitigate inflation, particularly in energy, labor and materials.

Looking into FY '20, we remain absolutely focused on cost-reduction opportunities to ensure we maximize margins, particularly in a lower commodity price environment. Our flexible and disciplined approach to capital management remains unchanged. We have delivered $672 million in returns to shareholders in respect to the period and have over the past 4 years returned 27% of our market capitalization. We will continue to be disciplined in our approach, and opportunities outside our portfolio will compete for capital with shareholder returns. We are focused on sustainably improving our operating performance to capture higher margins while continuing to make disciplined capital allocation decisions, prioritizing a strong balance sheet to ensure we retain flexibility through economic cycles while creating competition for excess capital and creating value for shareholders.

I'll now hand back to the operator, and we'll take questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Paul Young from Goldman Sachs.

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Paul Young, Goldman Sachs Group Inc., Research Division - Equity Analyst [2]

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Graham, first question is on your manganese production guidance and, I guess, strategy. I see that you're guiding to a small decline in South African production but quite a decent uplift in the Australian manganese production volumes. Just wondering if that's really you trying to maximize margin in that business. And then secondly to that, on GEMCO, I noticed the strip ratio is going up, I think, by 10% to 20% in FY '20. Can you maybe just talk through what that profile looks like beyond FY '20?

And then secondly, staying on your big assets. Worsley, your FY '19 cost performance. We go back to your guidance, you actually did miss that unit cost number. Part of that's probably production-related. But just curious about that drop in costs in FY '20? And what gives you the confidence you can hit that number?

And then lastly, Graham, along -- just on alumina, the market. In the past, you said that the long-run costs you look at is about sort of 350 to 370 driven by long-run marginal costs in China. What are you seeing at the moment on marginal cost in China, what that level is at?

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Graham Kerr, South32 Limited - CEO, MD & Executive Director [3]

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Yes. Thanks, Paul. A lot of questions there, so I'll probably break them into parts. If you think about the manganese ore outlook, what I would say is that we would comment that we are seeing downward pressure on prices. And we expect that to sort of flow through to the second half of calendar year '19 as we see weaker steel markets, lower alloy margins, slower destocking of higher port stocks and weaker currency impacts. Now in saying that, we do expect to see a bit of, if you like, support in the price as we get back towards the end of the year, as we particularly see some of the higher-cost producers start to fall out the marketplace. What does that mean for us? We have always been very clear that GEMCO is the best asset in the industry. It's the lowest-cost producer, it's higher quality, closest to the customer. We'll continue to run that full bottle, and you will see that we continue to run the PC02 circuit above nameplate capacity, about 120%.

South Africa Manganese, we've really been opportunistic over the last 12 months. Where possible, we've actually got a lot of, obviously, tonnages that we can send down the road if the actual economics hold up. We continue to watch that all the time. If we think about where we are today, we think that business in terms of South African manganese has the ability to expand, particularly vessels underground and also what we can do with a rapid train load-out facility to maximize our rail allocation and take some tonnes off the road. And while we have shown, obviously, an increase in production this year, I always caveat that by talking about that depends very much on the market demand, particularly in South Africa.

Paul, perhaps you can comment on the GEMCO strip ratios.

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Paul Harvey, South32 Limited - COO [4]

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Yes. Thanks, Graham. Just want to comment on the manganese production. There are a couple of significant shuts planned into the cycle this year around risk reduction with some of the infrastructure. So they've been planned for a long period of time, one at vessels coming up in September. So I think the deviation you're seeing in SA Manganese is also partly just due to some planned maintenance activity during the course of the year.

GEMCO's strip ratio, yes, there is a gradual increase again this year. We've seen waste movement over the last 3 years increasing from sort of mid-30 million tonnes to -- into the 50s now. So it is continuing to increase. There will be periods where it stabilizes for a year or 2 here and there, but the path going forward, particularly with the material that's left in the current western leases and working areas, we will see a gradual increase in strip ratio year-on-year. That said, the team is doing a fantastic job. If you look at the unit costs and you consider those volumes moved, the team is doing a great job, particularly focusing on uptime in the process plants. Over a period of 4 or 5 years, working on the shutdown cycles, uptime in the process plant is sort of ticking up 100, 120 extra hours a year over the last 3 years, which is having significant supporting impact, and also some good progress and some really positive work on equipment performances, particularly with the dozer fleet and the excavators. So we're working hard to compensate from a unit cost point of view given the headwinds of strip ratio.

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Graham Kerr, South32 Limited - CEO, MD & Executive Director [5]

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I guess the other one, Paul, is we do plan to get into southern leases with the EIS being done around September, October this year, depending on obviously government approvals. But that's the expectation at the moment. Mike, perhaps on Worsley, do you want to talk about Worsley guidance for FY '19?

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Mike Fraser, South32 Limited - COO [6]

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Yes. Thanks, Graham, and good morning, Paul. Look, I think there's a couple of things. So probably 12 months ago, when we had a closer look at Worsley, we realized there was a bit of work that we needed to do to deliver stability. Clearly, the big kicker is if we can get Worsley back to its nameplate capacity of 4.6 million tonnes, which we think we're going to come really close this year and definitely guiding into '21 that we'll hit that number. In order to deliver that, we realized we needed to do a bit of work back on the calciners. So we invested some money in the year -- in FY '19 to get those calciner performance back, and I'm pretty confident now that we've got the calciners back close to where we need it to be. One of the big calciners, [Cal 5], is actually out now. And once we've got that through by the end of -- probably mid-September, we'll actually be in pretty good shape on the calciners.

I think the second area for us this year is that we're starting to see some of the benefits of some of the revised energy contracts coming through. So we renegotiated a couple of the gas contracts. We'll see some of that benefit coming through. And also last year, we did some work around some of the piping in the digester, which was some of the work -- remedial work under the old [ENG] piping that we picked up some challenges with. So there was additional cost that we deliberately put back into the business in FY '19 in order to deliver our stable production profile. So I'm pretty confident that this year, we'll see some of the benefits of that flowing through, and those one-offs that we took in '19 will come out this year. So yes, I mean, there's certainly a bit of a plug in that, but we'll definitely drive to that outcome.

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Graham Kerr, South32 Limited - CEO, MD & Executive Director [7]

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Probably fair to say, Mike, in the first -- last couple of months, we've seen a real uptick in some of those key metrics as well as some of that work starting to play out already.

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Mike Fraser, South32 Limited - COO [8]

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Absolutely. I think first 6 months -- the first 6 weeks of this year already are much stronger, yes.

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Graham Kerr, South32 Limited - CEO, MD & Executive Director [9]

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Talking about the alumina market. Paul, I mean, obviously, at the moment, we continue to see weakness in terms of the price, particularly as Alunorte resumed 3 million tonnes of production, and we've also seen new Chinese capacity come online in calendar year '19, about 5 million tonnes. While prices are under pressure due to that high global supply and really lackluster Chinese aluminum demand, we do see some potential upside if we see enough curtailments occur during winter that are planned to be -- planned for the next few months. If those curtailments don't plan out as expected, well, then you'll probably see that the market is expected to be in surplus by about 4 million tonnes globally. Paul, does that sort of cover your questions? There's quite a lot of in there. Just want to check we didn't miss anything.

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Operator [10]

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Your next question comes from the line of Lyndon Fagan from JPMorgan.

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Lyndon Fagan, JP Morgan Chase & Co, Research Division - Analyst [11]

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Look, the first one is just on the South African Energy Coal transaction. Just a clarification. Do you mind sort of letting us know how much cash is in the net assets? And what your cash balance would fall by post that transaction? That's the first one. The second one is really just about Hillside. It's made almost $100 million loss, and we've got a step-change up in the power contract. Just wondering if you can update us on any discussions with Eskom, how we should be thinking about that from a modeling perspective. And then more broadly, it's obviously not profitable through the cycle at the moment. We've got costs going up. At what point would you consider idling part or all of the asset?

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Graham Kerr, South32 Limited - CEO, MD & Executive Director [12]

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Okay. Thanks, Lyndon. Look, maybe just taking those in parts. It's probably a good opportunity, if you don't mind, just to remind people about the SAEC transaction, and then I'll get Katie to talk quickly through the numbers. And I'll get Mike to actually give you a rundown on Hillside.

I think one of the things I wanted to talk very clearly about SAEC, the strategic rationale that we spoke about at the start of the process remains unchanged. This is our most difficult and largest footprint in any place that we operate. The commodity attractiveness long term of thermal coal is questionable. It does have growth options, but they're very much orientated towards the domestic market, where we're not the preferred supplier, i.e., looking for preferred black suppliers. And I guess I've been quite consistent in the record that from our perspective, the business has large closure liabilities. If we can get a truly transformed owner and we can transfer all assets and liabilities, I'd be happy to take a dollar. And if you think about strategic benefits on top of that, it will absolutely reduce our capital intensity, improve our return on invested capital and margins. What we have at the moment, I guess, and what we've spoken about over the last 12 months is a rather comprehensive and competitive process. We have signed an exclusivity agreement with Seriti. So there's still work to be done in terms of negotiating a final sales and purchase agreement. And that includes, obviously, now giving them access to the black box and some of the other more confidential contracts, but we don't expect any surprises in that. We absolutely believe it's the best deal on the table for all stakeholders in terms of achieving what South Africa is looking for in terms of Eskom, DMR and the ANC. But I guess it's important to note, as early as we started talking about this, and we included a slide in the slide pack, we started talking about this at the end of -- towards calendar year '17. And what we have done, as we committed, is that we would set the business up sustainably. So while we talk about spend into the business in '18 and '19, we have invested into SAEC CapEx of $377 million to make that sustainable business. Important to note that, that cash flow has actually come out of cash generation in that business. And really, what the impairment does is writes off that historical investment in property, plant and equipment and de-recognizes deferred tax assets. The value of the actual deal in terms of the upfront payment and also deferred consideration will actually offset most of the FY '20 free cash flows. So if you think about that objective of $1 and all assets and liabilities transferred, we're reasonably on track to achieve that. Obviously, we're still going to go through competition and other regulatory approvals in South Africa and finalize the deal. But it's important to note that all assets and liabilities will be transferred as part of that business.

Katie, maybe just talk a little bit about cash and working capital we have in SAEC at the moment.

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Katie Tovich, South32 Limited - CFO [13]

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Yes. Sure, Graham. So I think you've stepped through the process quite clearly there in terms of cash sitting in the business. And if you have a chance to look at the slide deck, on Slide 8, we do show the difference between net assets post the impairment and net operating assets, and that's roughly $200 million. So that cash that's remaining in the SAEC business will contribute towards funding FY '20 cash flows, as Graham mentioned. In the -- I guess, in aggregate, with expected modest upfront payments and deferred consideration, we don't expect any further cash outflows from the group in terms of funding FY '20 capital and operating expenses. There will be variability, obviously. So the business will remain in our underlying earnings until we complete the transaction. So as you see price and FX move, obviously, our expectations around SAEC's cash working profits through the year will vary.

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Graham Kerr, South32 Limited - CEO, MD & Executive Director [14]

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Mike, did you want to answer the Hillside question?

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Mike Fraser, South32 Limited - COO [15]

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Yes. Good morning, Lyndon. Look, I think just a couple of things to break that down. On the cost side, I think if you look at the Hillside, we still think -- and yes, we have to complete the engagement around the revised power contracts, and I'll come back to that in a minute. But even with that, if you look at where Hillside's cost drivers are, between 50% and 60% of the costs really come from raw materials, so that's coke, pitch, alumina. As you go into FY '19, across the entire smelter universe, everyone was under significant pain, particularly due to alumina. And obviously, we benefited on the other side in terms of the price gain on alumina.

If you look at the energy costs today, they're -- probably between 15% and 20% of Hillside's cost is electricity. So even if you want to model in a view that this is going to be a higher cost to Hillside, it's not going to be the most substantial driver, although it will be important. I think the way that we need to think about the cost, and this is a journey for us, is that we are seeing a normalization and retreat of some of those raw material inputs. And I think this is the bit that we've got to probably think about in terms of the entire sector, is that you do see that margin flow from time to time between alumina and metal. And I think the one last thing that we've got is an opportunity to take that margin on both sides, depending where that margin flows. So even though Hillside, as you say, was even negative in the year, we certainly took significant advantage of that through Worsley. But having said that, we haven't stood on our hands at Hillside. And the team, in driving the 20% of controllable costs that they do control, there's been significant work done in the year to try and reset that business. We took just under 500 people out of that business in the last quarter of last year. And even with those headcount out, we're still seeing good operating performance in the year. We have changed the operating philosophy there. So we've brought in production technicians who actually do first-line maintenance in the workplace, and that's certainly looking to be a good model that we look to replicate at Mozal.

In addition, we've done some outsourcing of activities, and we've been able to identify partners that can actually do some of the tasks better than us, particularly around internal transport, et cetera. So those kind of things will start paying off. We're looking at trials on low-vanadium coke, for example, which help us to drive down some of the raw material input costs. So we're quite confident that we can continue to drive value out of this business. But as you rightly identify, this is a business that -- it will continue to go through a bit of feast and famine. But all that I can say is that in our integrated value chain, we do see that value migrating between the businesses.

In FY '20, one of the other dimensions of -- or sorry, '19, the other dimensions of cost is that we had a very high pot relining year. So we've relined 171 pots, which is probably a peak relining period. In FY '20, we go down to 79. So again, that's a contributor.

And I think just coming back to the power contract. We probably can't say a lot more, except that we probably are getting quite confident that we are getting to a point where we have -- will have a contract that will give us a sustainable future at Hillside. It will be more like a Mozal-type contract. We will probably take away some of that protection -- inherent protection we have on the downside in terms of the LME linkage, but it will probably be a fixed rand-based contract as opposed to the U.S. dollar contract. So we'll potentially get some swings on the currency protection as well. So hopefully, at the half year, we'll be in a better position to give you a view on what that looks like. But at this stage, we still think that we're in good shape to get conclusion ahead of the period at which the dispute kicks in, which is essentially at the end of this current financial year. But again, I think just bear in mind that power currently is between 15% and 20% of the cost base. So even if you're bearish on what we can achieve, it's not the biggest driver of the cost base.

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Graham Kerr, South32 Limited - CEO, MD & Executive Director [16]

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Lyndon, maybe just a couple of additional comments on Hillside is, one, important to recognize that what Mike said is part of the value chain, where the money moves up and down. It is a business that requires low levels of CapEx compared to many other operations. And we can confirm it as absolutely cash positive in July as some of those benefits and pressures on raw materials came off.

Did we address all your questions here, Lyndon? Do you have any follow-ups?

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Lyndon Fagan, JP Morgan Chase & Co, Research Division - Analyst [17]

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No, that's great. Very helpful. So just to confirm, if we're carrying South African Energy Coal at 0 post the sale, we reduce our cash by about $200 million?

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Graham Kerr, South32 Limited - CEO, MD & Executive Director [18]

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Katie?

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Katie Tovich, South32 Limited - CFO [19]

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Yes. So effectively, if you're carrying South African Energy Coal at nil at 30 June, the deferred consideration and the cash remaining in the business will be sufficient to fund our FY '20 cash flows based on the current price and FX assumptions that we have noted.

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Operator [20]

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Your next question comes from the line of Rahul Anand from Morgan Stanley.

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Rahul Anand, Morgan Stanley, Research Division - Equity Analyst [21]

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I've got 3. If I might start with SAEC, and apologies to keep asking questions on that. But just wanted to understand, considering it's not binding at the moment, is there anything further you can provide in terms of who the other bidding parties were? And if this doesn't go ahead, if we have a fallback option also in place? That's the first one.

Second one is just a quick one on the debottlenecking Phase 1 at Brazil Alumina. It was completed in 2018, and we're seeing some delays there in terms of realizing the benefits of that. So wanted to understand how we should be thinking about that and what these potential issues have been?

And then thirdly and finally, look, at the time we did our initiation, we've done some work around breakeven analysis on the manganese tonnes on trucks in South Africa, mainly around that 32% to 37% grade. And we've come up with a breakeven figure of around $6. I wanted to sort of understand, is there an understanding internally in the business around where that breakeven cost might be in terms of the cost support levels perhaps for these additional tonnes in South Africa for the manganese market?

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Graham Kerr, South32 Limited - CEO, MD & Executive Director [22]

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Yes. Let's walk -- work through these one by one. If we talk about SAEC first, I mean, there's not too much more we can talk about at the moment with the deal with Seriti other than what's been outlined in the presentation. Important to note, it's an exclusivity agreement, and that was important, a, to get access to some of the final contracts that, while they're probably well and truly aware of, we haven't shared officially yet. The second piece is you'd be aware in South Africa, there's a process now of engaging with stakeholders, ranging from the DMR, Eskom, et cetera, that we wanted to be very transparent around that so people would see it. So we have to publicly announce it. The process itself, we were being very clear that it's been a long competitive process, and that's to make sure that we're managing all the issues that can occur in South Africa. We took 2 people through to the final stage. We had 3 eventually, but we decided 2 were the most attractive. Their bids were both very competitive. But we do think that Seriti, if you like, offers a more complete offer in terms of what it means for Eskom but also the synergies that naturally come by adding the 2 businesses together, where there is strong overlap not only in mining leases but also in equipment that they will need. So we think that was a very good fit. And also, when you look at Seriti, their track record, and obviously Mike Teke, who runs it, we know very well has an excellent reputation, so that all come into the thesis.

If you talk about the debottlenecking when it comes to Brazil Alumina, important to understand that it's actually managed by Alcoa. But really, the challenges over the last period of time have been around the boilers and getting them to work properly. They brought in some temporary boilers to handle the steam generation, which has been working, but we expect them to sort of get back to the recovery of that later this year and then move into Phase 2 on that site.

In terms of the breakeven price at manganese, we generally -- [we know there's] talk. We always take it back to the 44% [sitch]. And you're probably talking about a price in our numbers around $4.06. So if you do a grade adjustment for that, you can probably work back and reconcile it to your number.

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Operator [23]

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Your next question comes from the line of John Tumazos from Very Independent Research.

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John Charles Tumazos, John Tumazos Very Independent Research, LLC - President and CEO [24]

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Could you clarify the South African coal guidance? Do you expect to complete the transaction and have the liabilities off your books in the next earnings report, year-end June 30, or would it take longer? And second question, and I realize coal and aluminum are different businesses. But is this a template potentially for the aluminum smelter business as well?

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Graham Kerr, South32 Limited - CEO, MD & Executive Director [25]

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Yes. Let's maybe break those in parts. If you talk about the timing, obviously, we've got to negotiate the final sales and purchase agreement. But we're pretty well progressed on that and been working really hard on that piece. I think the bigger issue in South Africa that we've spoken about from day 1 has been getting all the necessary approvals, and on average, you're looking at somewhere between 9 to 12 months. The way we've projected, if you like, or put out to the market this transaction, is we would expect it to be finished by the end of our financial year, which is June next year, obviously, subject to getting those necessary approvals. And obviously, we manage the business between now and then. They priced their offer based on the value of the business essentially at 30th of June just past. And obviously, there'll be a cash working capital adjustment as we go forward. But any profits we make this year essentially [base] it towards South32, not Seriti.

If you talk about is this a template for what you can do in Hillside Aluminium? Look, I think they're very different businesses. We talked very clearly about the South Africa Energy Coal business has by far our largest footprint. It attracts a lot of social, safety challenges in the South African context. It is a commodity that long term is really around the energy coal-producing asset. It's a commodity that we think has some challenges mid- to long-term around the fundamentals. And the business itself is very much orientated towards producing in the future with growth opportunities, more domestic products for Eskom, which is a local energy-generation state-owned enterprise. So from our perspective, to be a global multinational company investing in growth projects that are domestic-orientated to earn a utility-type return for a country at the country's premium doesn't make a lot of sense. So I don't think Hillside and the aluminum smelters are the same with this. As Mike rightly pointed out, we do see and we play obviously in the value chain from bauxite alumina to aluminum, and we do see the value shift up and down.

Now in saying that, I think one of the things that we will do over time in Hillside is we will look to actually have some impairment of that business. But that impairment of that business would be for, like, market value, and there'll be a number of interested parties in that space. And you're probably looking at somewhere between 20% to 30% in that space. But that's not urgent for us at the moment. The most important thing from our perspective is to actually close and finish this SAEC transaction. Does that help, John?

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Operator [26]

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(Operator Instructions) Your next question comes from the line of Peter O'Connor from Shaw.

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Peter O'Connor, Shaw and Partners Limited, Research Division - Senior Analyst of Metals and Mining [27]

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Graham, just circling back to Energy Coal transaction again. The press is not always right. But sometimes where there's smoke, there's fire. And the number that's being reported of late is a $300 million to $400 million transaction number. So I'm just trying to square up in my head what you're talking about with the transaction taking 9 to 12 months to complete, you pick up the profit over the next year. You've got cash outflow to run the business for the year. If there's this $300 million to $400 million floating around out there, what does that number reflect? Or is it just to complete [for a fee]?

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Graham Kerr, South32 Limited - CEO, MD & Executive Director [28]

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Yes. Look, I mean, I wouldn't get too carried away on what you read in the media. I think there is always some smoke, but it doesn't mean that they have their numbers accurate. As we've said, there is a modest upfront payment and then there's the deferred payment. And if you think about the magnitude of those 2 amounts, that roughly comes in to cover our FX for next year, plus our expected operating performance. That gives you a rough sense of what we're talking about.

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Peter O'Connor, Shaw and Partners Limited, Research Division - Senior Analyst of Metals and Mining [29]

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Just by way of adjectives, because we're on these calls, I'm always trying to second-guess what you're saying. What is modest? How do you define that? And could that true-up payment be a payment back to Seriti as opposed to a top-up from them if steaming coal price heads lower or stays lower?

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Graham Kerr, South32 Limited - CEO, MD & Executive Director [30]

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No. It's only the upside that gets shared. There's no downside. The way I think about next year, on the slide, I guess, we've given you the CapEx out the door, which is roughly $200 million. We've also given you the price that we're doing our calculations on for thermal coal. We've also given you the FX. But you can sort of work out the operating performance of SAEC based on that. Add those 2 numbers together and I'd say, look, we're mostly covering that in what we expect to receive. Now in saying that we have signed an exclusivity, we still look to get a sales and purchase agreement finalized.

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Katie Tovich, South32 Limited - CFO [31]

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And maybe just to add, the deferred consideration, it could be valued differently depending on your price and FX assumptions. So there may be different numbers that people are talking about in terms of the context of how they think about the value of that deferred consideration.

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Graham Kerr, South32 Limited - CEO, MD & Executive Director [32]

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I mean, the business, Rocky, is -- obviously, as you're well and truly aware, it has and continues to be very sensitive to movements in both FX and thermal coal price. So there are things that will come into play when you consider the deferred consideration. But to be clear, there is no downside on the deferred consideration.

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Operator [33]

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Your next question comes from the line of Glyn Lawcock from UBS.

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Glyn Lawcock, UBS Investment Bank, Research Division - MD, Head of the Australian Mining & Energy Team and Research Analyst [34]

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Just thinking of your balance sheet, obviously, this transaction, as you say, makes the balance sheet look a lot better. How do you think about the balance sheet being -- I mean, I know it could be 12 months before we conclude this deal. But how do you think about where you'd like the balance sheet to be once this deal closes? Are you still -- we've always sat with net cash. Like how does it change your feel towards the balance sheet?

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Graham Kerr, South32 Limited - CEO, MD & Executive Director [35]

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Yes. Thanks, Glyn. And I mean -- and maybe I'll get Katie to answer that as she used to be our treasurer, and now she's our CFO so she can give you her view in the seat. What I would say is our approach to -- if you think about our priorities around capital management and the framework we've spoken about, that remains unchanged. It's just about, well, what does that postcard look like? And Katie, maybe you can talk about how we think about it today and obviously the work we're doing at the end of it.

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Katie Tovich, South32 Limited - CFO [36]

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Yes. Thanks, Graham. So I guess, yes, Glyn, we have talked historically about the 0 to $500 million net debt range. And I guess given the introduction of the noncash-generating growth projects that we're looking at, at this stage, we're probably more in that [post-guidance] 0 to $250 million net debt in terms of that range right now. But as Graham said, as we work through the process and finalize the negotiations with Seriti, we will reassess our balance sheet and net debt range. But certainly, as highlighted, with the removal of the assets and liabilities from our books at the completion of the transaction, we certainly expect our balance sheet to be in a better position post the completion of that transaction.

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Graham Kerr, South32 Limited - CEO, MD & Executive Director [37]

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And at the end of July, Glyn, we have $644 million, if you like, in net cash, of which, obviously, $140 million's earmarked for ordinary dividends. $264 million is actually earmarked for the continuation of the capital management program. And the other piece, obviously -- and that is we also have potentially a decision to make on Trilogy for $150 million in January. And we haven't committed one way or the other around that yet. We like the prospectivity of what's going on. But there are a couple of key milestones this year around further exploration work and also the EIS on the road to allow them to actually open up the Ambler district. These are all things that will come into consideration. What hasn't changed, I guess, is probably 2 things. We do believe in consistency around the capital management piece and doing it through the cycle, and the other piece would be that we'll always talk about it when we've got the money in the bank and do it on the cash that we have and not prospective cash. And obviously, if we make more cash than we expect, as we've done in the past, we'll look at revisiting what the capital management thresholds look like. Does that help, Glyn?

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Glyn Lawcock, UBS Investment Bank, Research Division - MD, Head of the Australian Mining & Energy Team and Research Analyst [38]

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Yes, it does. But I guess the bottom line is, you would be happy to carry slightly -- but you've always carried a net cash position even after all your projected outflows. What you're sort of saying is, if I read between the lines, you didn't carry a projected net debt position based on projected outflows now rather than net cash (inaudible) deals done?

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Graham Kerr, South32 Limited - CEO, MD & Executive Director [39]

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I think we did, yes. Yes, and I think the key there is obviously the deal -- getting the deal completed. I think the other piece that will come into the equation is if we also obviously got the finalized numbers around the cost at Hermosa, make a decision on Trilogy and also get a sense of Eagle Downs. They're all things that will go into the mix as we get that. What we wouldn't probably shy away from is that we still believe, [i.e.,] in that capital management program and that trading competition for excess capital, but we also honestly believe in having a strong balance sheet. And some people might say we're a little bit too conservative on that space. But I guess being in the industry long enough to see that it's very hard to predict where commodity prices will go. And in the current climate, I'm not saying we're pessimistic, but there's probably a bit more of a tendency in the short term to uncertainty around the macros.

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Glyn Lawcock, UBS Investment Bank, Research Division - MD, Head of the Australian Mining & Energy Team and Research Analyst [40]

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Yes. And Graham, maybe on that comment then. Is it your customers that you -- is it just the macro? Like it's everyone's nervousness around what's going on rather than physical (inaudible) demand at the moment?

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Graham Kerr, South32 Limited - CEO, MD & Executive Director [41]

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I think it is a combination of both. I mean, obviously, there's a lot of tension and price volatility that you're seeing at the moment, Glyn. I think, again, there's lot of talk around the uncertainty of Brexit, politics in Italy, is the U.S. kind of sort of weakening in terms of economic performance. I think they are all considerations. I think we're a bit more realistic in thinking that, if you think about the short to medium term, there obviously is a rivalry going on between China and the U.S. that I personally think is broader than just trade. But I think that's a fact of where we are at the moment. We do see a weakening steel demand in the second half of the year because, obviously, they're not making the money they expect. What we will watch is how Chinese policy reacts. At the moment, they're not going for the big bang approach. They're doing more incremental, if you like, on stimulus. As long as they can balance that, we think it's actually still an attractive place to be.

But the difficult one is just knowing how the trade war rolls out and how both the Chinese and the U.S. react. Again, I'll come back to the position that most of our commodities are in a good position on the cost curve. We do believe in keeping that strong balance sheet, so we stay in control of the business. And as we think about the future, the things we're adding to the portfolio, we believe they're going to be products that have stronger demand in the future and not weaker demand like perhaps something like thermal coal, where the demand is a little bit more uncertain maybe into a longer term.

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Operator [42]

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

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Paul Young, Goldman Sachs Group Inc., Research Division - Equity Analyst [43]

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On -- a few questions on your growth projects. First of all, Hermosa, you're spending $110 million in FY '20, which is a fair amount for a project which is in pre-feasibility study stage. So just curious, of that $109 million, how much of that is actually -- you believe actually will make up the project's budget when approved? So how much of the project are you actually spending on infrastructure, which is actually -- will be made up on the final budget number?

And then secondly, on Eagle Downs. The timing seems a little bit delayed to me. Feasibility study at the moment, but expectation on final investment decision only in the first half of FY '21. Just curious around that timing, considering the amount of work that's already been done on the underground. And then lastly, a lot of projects ongoing in Queensland at the moment. And a lot of that spec port capacity is filling up. So can you just remind us about the port allocation you secured for Eagle Downs?

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Graham Kerr, South32 Limited - CEO, MD & Executive Director [44]

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Yes. I'll do the first one, if you like, Paul, around Hermosa, and then I'll get Paul Harvey to talk about the Eagle Downs, the 2 components because he's looking after Eagle Downs at the moment.

Look, if we talk about Hermosa and we talk about that CapEx of $109 million, the bulk of that money is actually going into surface infrastructure around water treatment. It's also going into some power to the site, the setup of the underground portal and also some land acquisitions, if you like, that give us, a, some flexibility but also laydown areas and potential bypasses to get the product, if you like, out of the mine. So I'd say the bulk of that $109 million is not related to the permitting and environmental and the admin component. It's all related to tangible hard infrastructure that will be part of the project.

Eagle Downs timing, Paul?

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Paul Harvey, South32 Limited - COO [45]

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Yes. Thanks, Graham. And hi, Paul. And sort of the second question sort of feeds partly into the first question, I guess. In terms of study timing, there is some other work ongoing as well as just the study. So for example, some additional drilling that we're doing at the moment and some other drilling plans that will sort of feed into, again, some of our quality assumptions. So it's not just study itself, it's some additional work being done to sort of supplement understanding of the resource and resource quality. So that adds to the timing.

And you're right. Also, from a sort of off-site logistics and sort of rail and ports perspective, there's considerable work for us to do in that space as well. So they're some of the things that are contributing to timing that'll take us to probably this time next year or a bit beyond.

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Paul Young, Goldman Sachs Group Inc., Research Division - Equity Analyst [46]

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So just expanding on that, Paul, just on the port capacity, what are your options now? And where are you looking at, which ports?

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Paul Harvey, South32 Limited - COO [47]

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I guess there's a couple of options. The team are busy sort of assessing those at the moment. You're right, there is competition there for port capacity in some of the ports. So initially, [D'Errico Bay] but also looking at Abbot Point. So we've got a number of options that we're considering. It's probably just a bit early at the moment yet. We need to do the work.

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Graham Kerr, South32 Limited - CEO, MD & Executive Director [48]

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One comment I want to add, Paul, one of the things we are starting to see (inaudible) across the (inaudible) as well. So I think in the Bowen Basin (inaudible) at the moment and to be able to [procure] where (inaudible) Illawarra, [so we expect to take hold of some of its] (inaudible) development units around continuous miners. And that's the function of what's going on in the Bowen Basin but also civil construction on the East Coast. And obviously, now in Western Australia, you're starting to see the iron ore sustainability [projects round] up. So I think that is the challenge for the industry that we need to continue to watch. So yes, does that help, Paul? (inaudible).

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Paul Young, Goldman Sachs Group Inc., Research Division - Equity Analyst [49]

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Yes. It does. So there's 2 factors there. There's a labor component and access to contractors, and there's port consideration as well. That's the summary?

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Graham Kerr, South32 Limited - CEO, MD & Executive Director [50]

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Yes.

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Operator [51]

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Unfortunately, we have run out of time for any further questions. I would now like to hand the conference back to Mr. Kerr for closing remarks.

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Graham Kerr, South32 Limited - CEO, MD & Executive Director [52]

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So thank you, and thanks, everyone, for the opportunity today to talk about our business.

To be clear, we're focused on sustainably improving our operating performance to capture higher margins. We continue to add options into the portfolio for future growth as well as, if you like, optimizing that portfolio while all the time having the lens of making disciplined capital allocation decisions where we prioritize a strong balance sheet, but make sure we -- by making sure we have that flexibility to manage our business through the economic cycles while always creating competition for excess capital and creating value for shareholders.

The SAEC transaction for us, obviously, it was important to share with you today how we're progressing in that space. There is more work to be done. But if I go back and look at the performance in that space, while there is more work to be done, go back to the strategic objectives when we started the process. [They're a tick]. If you go back and talk about Seriti as a counterparty, they're absolutely a [tick] in terms of performance, values and also expanding in South Africa. And obviously, we look to complete that transaction over the next 12 months, which I think, again, improves the quality of our portfolio in terms of margins, returns and the strength of our balance sheet as we think about the future. So thank you, everyone, for today.

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Operator [53]

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