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Edited Transcript of S32.AX earnings conference call or presentation 22-Aug-19 8:00am GMT

Full Year 2019 South32 Ltd Earnings Call (UK and South African Investors)

PERTH Sep 11, 2019 (Thomson StreetEvents) -- Edited Transcript of South32 Ltd earnings conference call or presentation Thursday, August 22, 2019 at 8:00:00am 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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* Anthony Robson

Global Mining Research Pty Limited - Executive Chairman

* Brian Morgan

Morgan Stanley, Research Division - Equity Analyst

* Edward Christopher Sterck

BMO Capital Markets Equity Research - Analyst

* Izak Jan Rossouw

Barclays Bank PLC, Research Division - Director

* J. Timothy Clark

SBG Securities (Proprietary) Limited, Research Division - Head of Metals and Mining

* Sylvain Brunet

Exane BNP Paribas, Research Division - Head of Metals and Mining Equity Research

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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 Full Year 2019 U.K. and SA Investors Analyst Teleconference. (Operator Instructions)

I'd 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. Thanks, everyone, and welcome to our U.K. and South Africa investor and analyst teleconference for FY '19 results.

I'm joined today by our Chief Financial Officer, Katie Tovich; and our Chief Operating Officers, Paul Harvey and Mike Fraser. Mike joins us on the line from Johannesburg.

For those of you who couldn't listen to Katie's webcast, I'll share a short summary before we open the line for questions. We'll get through as many as we can, but if you don't get the chance to ask your question please give our Investor Relations team a call.

Moving to our results. A strong operating performance across the majority of our operations saw group production volumes increase by 3% during the year. Some of that key highlights included record production at Hillside Aluminum and strong performance at Mozal Aluminum as well as a 57% increase in volumes at Illawarra Metallurgical Coal.

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 shareholders and invested $1.5 billion in our portfolio through the acquisitions of Arizona Mining and a 50% share of Eagle Downs Metallurgical Coal. Demonstrating a disciplined approach to capital management and positive outlook for the business, today we announced an increase for our capital management program of $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.

We also made good progress as we continued to reshape and improve our portfolio. During the year, we completed the acquisition of Arizona Mining and acquired a 50% increase in Eagle Downs metallurgical coal project and released the mineral resource for the first time at the Hermosa project's Taylor deposit, which marked the key milestone as we progressed one of the most exciting base metal projects in the industry.

The 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 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 together to finalize the offer.

While the divestment substantially reduces our capital intensity strengthens our balance sheet and will improve the group's return on invested capital on operating margin, we have recognized an after-tax impairment today of $578 million to roll off our historical investment in PP&E and derecognize deferred tax assets.

Looking ahead, we are well positioned. Production volumes across the group are expected to rise by a further 3% in FY '20. We remain absolutely focused on cost reduction opportunities to ensure we maximize margins, particularly in the lower commodity price environment. Our flexible and disciplined approach to capital management remains unchanged. And we will continue to prioritize a strong balance sheet to ensure we retain flexibility through economic cycles while creating competition for excess capital and creating value for shareholders.

I will now hand over to the operator to commence Q&A.

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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 Sylvain Brunet of Exane BNP Paribas.

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Sylvain Brunet, Exane BNP Paribas, Research Division - Head of Metals and Mining Equity Research [2]

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My first question perhaps on the macro. Given the environment we are in, just curious to hear if you pick up any [concrete] evidence other than the sentiment from your customers changing their approach to inventory going into the new year? And if some commodities, some areas seem to be more exposed than others?

My second question is on the disposal of South African coal. Could you please explain why the operation wouldn't move under discontinued in terms of reporting. Is it just because you need more certainty on the regulatory approval and if you could perhaps remind us on the time line there?

And lastly, on Arizona Mining, I know it's still early days to comment too much on the CapEx but to the extent you could help us and share some of the progress of the work you're doing on the grounds and what are you best estimate at the moment if you have anything readily available?

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

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Yes perhaps taking those in parts. So I'll answer the safe one first. What we have announced this week is we've entered into exclusivity with Seriti which still means there's a number of steps to be taken. The first part is to actually share with them some of the blackbox information, work through some of the terms and conditions of their offer and start engaging with some of the external stakeholders who we'll need consent or endorsement from in South Africa and that ranges from Department of Mineral and Resources, South Africa Competition and obviously Eskom.

So that process itself we expect to stay somewhere between 9 to 12 months. And fair to say, if you think about the accounting standard, it means you're going to be more likely than less likely you're going to get this actually done. So you get a high level of probability of obtaining an exclusivity agreement you're not there today.

The question around the macro. Look, the macro, there is no doubt like everyone you've spoken -- probably spoken to. Yes, we have seen some of the downside risks that were flagged probably 12 months ago starting to come into the marketplace. I would say the rhetoric between obviously the U.S. and the China is part of that in terms of the trade war, but also the bigger, if you like, dialogue around some competition around ideological rivalries and the rise of another superpower. I think at the same time the uncertainty driven by what's going on with Brexit, Middle East conflicts, Italian politics and what is the economic outlook for the U.S. all sort of put you in a slightly more, if you like, downside than upside where we were 12 months ago.

But in saying that I would say we still see China growing at a slower rate, put off a larger base. You still see positive signs in India even though it's a bit slower at the moment in terms of growth. Medium to long term, look, I think it's a great industry to be in, in the commodity space because there has been a lack of investment over the last 5 to 10 years, demand continues to grow and supply doesn't come to the marketplace. So we certainly see that as a big opportunity.

If you think about some of the specifics we're seeing now, I would more say rather than the trade wars what we do see is some of our commodities get caught up in other issues. So for example, the political issue around Huawei and how that's playing out. It's well-documented that Chinese customs have started to basically have quotas on what you're allowed to bring in, in terms of coal into China. So while we don’t actually sell much of our metallurgical coal straight into China, all of a sudden we're seeing some of the, if you like, competition in the Bowen Basin and other parts of Australia not being able to land their coal into China. So they're now hitting some of the markets we operate in China and other places, Korea and Japan. So I think you're seeing some tension in the market on that space.

On the last question, sorry, the last one was around Arizona. If you think about Arizona, again I always remind people that we have always talked about components of value for Arizona. First one is the Taylor deposit and that's the one where we focused a lot of our effort on in the first 9 months of the acquisition. We've put out obviously our first resource statement and that was designed more about building confidence in what has already been drilled. We continue to actually do work on the resource because it's opened at depth than naturally.

The other piece here is there's a main -- there's a central deposit which is more manganese-based or manganese in it. We're doing some further work on that. And the greater land packages still apply interest for us because we think that's very perspective for more Tylor-like deposits and potentially in other parts of the land copper.

What we have done over the last 12 months is we have grown our footprint in that space by about 30% through land acquisitions. What we do plan to spend next year is roughly $109 million on the project and we'll also spend roughly $25 million in terms of exploration of the property. The $109 million is predominantly made up of work on the surface and that covers things like tailings treatment storage facilities, water treatment plants, getting power there, preparation of the underground portal and some land acquisitions.

So they're real tangible expenses on things that will go into the actual project. What we have said is, we are in the process of finishing the prefeasibility study, which we do expect to be completed by the end of this financial year. As we get closer to that point, we'll talk about CapEx. But generally drawing people back to the PEA to think about CapEx. We've always said there are always like -- probably about $150 million to $200 million of what they talked about, preproduction CapEx. And we've always said they're aggressive by a couple of years, if you like, in terms of the progress they plan to make. Our view probably hasn't changed in that space. But until we complete the study, we won't put out or share our own internal numbers.

But what I can say is certainly myself (inaudible) team continue to be impressed by the quality of the resource there and the potential upside that it offers. Again, I think we have the unique advantage in this space because the mining method, the customer base, the processing, is going to be incredibly similar to Cannington. So already we're starting to actually leverage some of those skills across into that business.

Not sure if that addressed all the questions or I missed something there?

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Operator [4]

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Our next question comes from the line of Ian Rossouw of Barclays.

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Izak Jan Rossouw, Barclays Bank PLC, Research Division - Director [5]

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Just 2 questions from me. Just on the 8 million-tonne target at Illawarra for 2021, I mean it's obviously something you've talked about before in saying that, that is quite a stretched number. Obviously, you require quite a big step up in development to get there. So I just wanted to get a sense, sort of the latest performance from the assets whether you -- you're sort of getting increasing confidence that, that 8 million-tonne number is achievable?

And then the second question, just follow-up on the SA Coal business. In the presentation you say -- and I guess you've mentioned this in the call this morning as well, that the value of the upfront in the third consideration is expected to offset the free cash outflows from the business. But in the Australian call you also included the $200 million cash position that will fund that. I wasn't completely sure if the business will be $200 million more cash negative or can you just maybe clarify that too?

And just clarify whether the third consideration will all be received in FY '20?

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Graham Kerr, South32 Limited - CEO, MD & Executive Director [6]

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So we'll do it in parts. Paul maybe you answer the Illawarra piece and Katie you can maybe talk with the piece around how the accounting looks from the cash flow for Australia.

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Paul Harvey, South32 Limited - COO [7]

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Thanks, Graham. Look, we are really happy with the performance of Illawarra over the past 12 months. So during FY '19, they've had a very strong year. They've reestablished a very strong and capable leadership group at that operation and you see they exceeded their guidance this year just finished. And we're starting to see some weeks intermittently, but some weeks such as Dendrobium recently over 150,000 tonnes a week from the longwall at Dendrobium, which obviously is an important part of the Illawarra complex.

So I mean really strong signs, really good progress. You did call out development. Obviously, a key enabler for sustained long-term reliable production is development. We are seeing an uptick in rates. Part of what's built into our plan this coming year is to increase the number of development units at Appin in particular, by 2. The first of those is in the mobilization stage at the moment and the second one planned for, I guess, the end of the first half of the fiscal year.

So we've got plans in place. I will point out. I think we might have discussed this on recent calls. It is a really tight market, particularly on the East Coast in Australia, but we're also starting to see that materialize in West Australia as well where sourcing skills, sourcing the right experience and trained labor for mining operations, particularly coal on the East Coast, is a real challenge. So it's not a lay down in the day for us, but the team are working very hard on this. They've got some great plans in place and as I say, the first of those contract units is busy mobilizing at the moment. So we're confident.

If you look at the production performance over the last year, you would have seen a dip in the earlier part of this -- of the second half. So quarter 3 of FY '19 that was obviously related to a longwall move. So we had 2 longwall moves last year, but the trajectory since coming out of that move is strongly positive and the team are heading in the right direction. So we've got confidence in those future plans.

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Katie Tovich, South32 Limited - CFO [8]

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Just over, I guess, to this SAC transaction, or proposed transaction. So in terms of maybe the best way to think about that is we've noted in our -- on Slide 8 in our slide deck, a CapEx of $205 million for FY '20 and the assumptions that we have in place around production and operating costs and our price and FX which you can model as your cash working profit outcomes for the business.

So I suggest you just, in terms of modeling it and how to think about it, assume we are running the business as you normally would for FY '20. At the end of FY '20, we would expect to receive payment -- an upfront payment as a result of the offer that's currently on the table. That will mostly offset the capital expenditure and cash outflows of the business throughout FY '20.

There is a component of the trade consideration that we -- that's also, I guess, variable in terms of price and FX outcomes. Still subject to finalization of course, but that would be something that we continue to have on our books over a number of years and to generate incremental income should price and FX work in our favor.

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Izak Jan Rossouw, Barclays Bank PLC, Research Division - Director [9]

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Okay. So -- and the $200 million cash that sits on -- in that business then?

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Katie Tovich, South32 Limited - CFO [10]

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That's just part of our normal operating business and cash flows and corporate consideration at this stage. So obviously as price and FX moves, the important thing to realize is that any gain or loss or profit or loss in that business will accrue to South32 as we move forward. And at completion of the transaction, all assets and liabilities then transfer to Seriti.

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Operator [11]

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Your next question comes from the line of Edward Sterck of BMO.

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Edward Christopher Sterck, BMO Capital Markets Equity Research - Analyst [12]

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Just a question on Arizona and permitting there. What are the implications for permitting, given the recent hearing against (inaudible) and expense of project. Just comments around that?

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Graham Kerr, South32 Limited - CEO, MD & Executive Director [13]

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Yes, look what I'd say is probably not a lot to change from our previous discussions, is if you think about Arizona and Hermosa -- let's say, Hermosa versus Rosemont, they are quite fundamentally different.

If you look at the visual picture, Rosemont you can see from one of the most scenic highways in Arizona, from both ends. They're essentially doing a large open-pit where they take away a mountain and they need to place all that material, plus you've got large tailing facilities that they need to place in quite public open space. A lot of that obviously will create lots of federal land. The most recent issue they had, which the view is it will be overturned through the courts, is there is a ruling that while they're putting that waste, if you like, on federal land and then when they've been approved to use, they technically can't do that because the land itself has no mining economic value. So that's an unusual kind of interpretation, which is expected to be overturned.

But if you saw the contrast Rosemont to Hermosa, when you talk about the Hermosa deposit it's underground because it's a much smaller footprint. It's actually up behind a town called Patagonia in the hills. So it's a really, if you like, community view and community interaction around it because it is underground the footprint is very small, the tailings aren't huge.

From the time we start production to when we run out of land, you're probably talking about 8.5 years depending on your production rate, 8.5 to 10 years, before you need federal approvals to place tailings on federal land. And on top of that we have a couple of options to actually process or move tailings to private land, which don't require those kind of federal approvals.

So while we still expect to have a relatively lengthy approval process because that's the nature of the game there, on average federal approvals in the U.S. have taken roughly about 6.5 years. So we think we've got plenty of time on our side. We've got quite different circumstances from Rosemont, but we're taking this very seriously. But clearly, you can't engage at a real meaningful level until you've worked out the configuration of the operation, whether it's 2, 4, 6, 8 million tonnes, and that's the work that will come out of the prefeasibility. But in between now and then, we're starting to obviously get the right permitting resources on board in preparation for that. But I wouldn't want you to confuse Rosemont and Hermosa as something similar in terms of mineralogy, deposit style, how it's going to be mined.

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Operator [14]

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(Operator Instructions) We have one from Brian Morgan of Morgan Stanley.

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Brian Morgan, Morgan Stanley, Research Division - Equity Analyst [15]

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Can you just give us an update on the negotiations with Eskom on pipeline 1 and 2, that's coming up pretty soon? I think it's the end of next year. Could you just give us an update on that?

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

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Mike, do you want to handle that one?

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Mike Fraser, South32 Limited - COO [17]

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Look, the -- I think we've made some really good progress. It's quite hard for us to go into specifics right now because we don't have a signed agreement at this stage. But where we are is we probably are pretty closely aligned now with Eskom on what this looks like going forward. There are a number of regulatory processes that we will need to run through, not least of which we'll have to take it through NERSA. But we're hoping that, that will get to them during this first half of our financial year. And I'm hopeful that by the time we get to our half year results, we will be in a position to talk a lot more about where we've got to.

But at this point in time, I'm fairly confident that we've got an agreement that will allow us to create a sustainable future for Hillside. And as we've always foreshadowed, this is likely to be -- one of the material changes on that will be -- it will be much more akin to a Mozal-type contract which is a fixed-rent type contract as opposed to an LME-linked, U.S. dollar-linked contract for [Part 1].

So that -- just to give you a sense. But I think we continue to make really good progress, I think, and I'm hopeful by the end of this half we will be able to give you a lot more information.

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Operator [18]

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Our next question comes from the line of Tony Robson of Global Mining Research.

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Anthony Robson, Global Mining Research Pty Limited - Executive Chairman [19]

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Looking a bit further out on 2 of your projects which you mentioned, the Cannington open-pit life extension bringing that forward using your spare mill capacity. If you were a betting man, would you say it's likely or it's a long-shot, I thought BHP had looked at that and rejected it several years ago?

And then secondly, just an update please on Eagle Downs, how that's going, so you've got a potential decision first half of fiscal '21. So if that does go ahead, can we be looking -- potentially looking at production, let's say, in 2024-'25?

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Graham Kerr, South32 Limited - CEO, MD & Executive Director [20]

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So look, I'll hand back those questions to Paul but I wouldn't make an overriding comment around Cannington, I guess. BHP's approach was to actually look at the open pit at the end of the life of the mine of the Cannington underground whereas I guess the approach we're looking at is what can you do in between to use that spare capacity and bring those cash flows forward. Perhaps, Paul you can talk a little more detail about how we're thinking about it?

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Paul Harvey, South32 Limited - COO [21]

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Yes, thanks, Graham. Tony, yes, you're right. So that project has sort of resurfaced, I guess, given the profile with the underground mine going forward where we have some capacity in the process but it's unutilized. It's currently in prefeasibility study, so it's got ways to go in terms of reaching some kind of recommendation or some kind of decision. So we've still got some work to do there, but definitely there is an opportunity there with that spare capacity.

At the end of the day, one of the key considerations is grade. It comes down to grade and prioritization of grade and how we would blend an open-pit operation into an active underground operation.

So it's [of tangible] aspects. It also had sort of [grade trials] that will impact on the outcome of that project. But it's -- we don't have an outcome yet. So it's probably 12 months away before we know what the right path forward for us might be.

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

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Eagle Downs, Paul?

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Paul Harvey, South32 Limited - COO [23]

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So Eagle Downs. Similar situation in that it's completing the first phase of the feasibility study, which is sort of a transition, I guess, from the work that had been done by the previous owners to a certain level. So part of that first phase of study for us was to revisit and review all the work that had been done in the past, identify where we felt there was opportunities to improve, also identify where good work had been done and there was plenty of that. So we're partway through that process at the moment.

And it's not just study-related work. There's also some of our investment related to additional drilling, not only resource drilling and definition drilling, but also focusing on structures. And in particular, a couple of holes looking at some larger samples to supplement our understanding of resource quality.

So the timing through to an FID, late 2020s, or first half FY '21 is not only because of the duration of the study work, it's also dependent on some drilling and some other study work to enhance our understanding of the resource.

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Operator [24]

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Next question comes from the line of Tim Clark of Standard Bank.

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J. Timothy Clark, SBG Securities (Proprietary) Limited, Research Division - Head of Metals and Mining [25]

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Just a couple of questions for me on -- again on projects. I would imagine that with GEMCO's life coming towards its end, there is a little bit of pressure on you to get into the southern leases and see if you can extend the life and sort of return that operation, consistent performance as opposed to having a dip in the end. And then, I guess, that sort of also ties back into the South African operations, and I've just got a question on vessels and potential expansion and I heard the sort of mentioning of a rapid loader opportunity. Just wondered if you could talk to timing on that because I would imagine that we're sort of moving quite fast towards the next manganese rail allocation, MECA3 discussions and I would imagine you'd want to get your place at the table.

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Graham Kerr, South32 Limited - CEO, MD & Executive Director [26]

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So maybe I'll get -- Paul can talk to the South African piece. Look, on GEMCO to keep it nice and easy, our position probably hasn't changed. We're hoping to get the EIS approval in September, October this year. And that will allow us to actually start drilling in the southern leases. To be perfectly honest, I say a few holes put in the southern leases, we've got no idea if there's 2 years or 20 years, what the grade like. That's why we want to get there and actually test it. Ideally, if it's a continuation of the orebody, that would be great. We just don't know the answer to that yet.

Paul, South African Manganese?

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Paul Harvey, South32 Limited - COO [27]

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Yes, South African Manganese. So you asked specifically, Tim, about vessels. So vessels is probably, certainly in the Kalahari Basin, the premier resource and the premier manganese basin on the planet. So we're very lucky to have that resource. It's long dated, as you know the current reserve and resource forecast for that operation is decades. So it's a great operation for us.

And you're right to highlight rail entitlement negotiations. They do come up in 3 or 4 years' time. One of the things we are looking at, at the moment with this cycle of our planning process is, is there an opportunity to further optimize the vessel's operation? You will recall we did some work to sort of rebase the operations in the Kalahari back in 2015 when we had this severe drop in manganese prices. The operation, as you can see, from its performance over the last 3 or 4 years has been progressively recovering that, but the year just completed a combined, sort of primary and secondary production, just tipped over the 1 million tonnes, which is showing that continuous improvement.

So you're right. And one of the pieces of work, we're looking at one of the opportunities to perhaps get further benefit from vessels is around rapid load out. We have our older-style train loading sort of facilities and approach at the moment. So rapid rail loader is going through study at the moment. We'd be looking to decide on whether that's the right approach for us later in this financial year, early FY '21, and then move forward with that project if it stacks up.

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Operator [28]

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As there are no further questions at this time, I'll now hand back to Mr. Kerr for closing remarks.

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Graham Kerr, South32 Limited - CEO, MD & Executive Director [29]

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Thank you. Thanks, everyone, for your time today.

And maybe just a couple of short closing remarks. Just one -- a couple of key messages to leave you with. Look, we are focused on sustainably improving our operational performance and our portfolio with the aim of capturing higher margins while continuing to make disciplined capital allocation decisions, prioritizing a strong balance sheet to ensure we retain the flexibility we need through economic cycles while creating competition for excess capital and importantly creating value for our shareholders.

I'd like to thank you for your time today. And obviously, if you've got any questions that haven't been answered, follow up with the Investor Relations team at a later date.

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Operator [30]

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Thank you. Ladies and gentlemen, that does conclude the conference for today. Thank you for participating. You may now disconnect.