Energy Transition Metals Demand Will Drive Strong Long Term Earnings Power

Catalysts

About South32

South32 is a diversified mining and metals company producing base metals and bulk commodities that are critical to the global energy transition and industrial supply chains.

What are the underlying business or industry changes driving this perspective?

• Accelerating global investment in the energy transition is driving structurally higher demand for copper, zinc, aluminum and manganese, which positions South32’s growing base metals portfolio at Sierra Gorda and Hermosa to deliver sustained volume growth and higher group revenue.
• The ramp up of low cost, near nameplate alumina and aluminum capacity at Worsley, Brazil Alumina and the Brazil smelter, combined with disciplined capital allocation, is expected to lower unit costs and support improving net margins as higher volumes amortize fixed costs.
• High quality, long life manganese and zinc assets such as GEMCO and Cannington, together with emerging optionality from new leases and open pit potential, provide leverage to tightening supply in key steel and battery raw materials and underpin resilient cash generation and earnings through the cycle.
• Hermosa’s Taylor and Peake deposits, together with the Ambler and Kalahari exploration hubs, offer a pipeline of copper and zinc production growth in geopolitically attractive jurisdictions. This supports a step change in future production mix and group EBITDA from higher margin base metals.
• A strengthened net cash balance sheet following portfolio simplification and non core divestments allows continued investment in selected growth projects alongside ongoing dividends and buybacks and supports higher free cash flow per share.

Assumptions

This narrative explores a more optimistic perspective on South32 compared to the consensus, based on a Fair Value that aligns with the bullish cohort of analysts. How have these above catalysts been quantified?

• The bullish analysts are assuming South32's revenue will grow by 14.5% annually over the next 3 years.
• The bullish analysts assume that profit margins will increase from 5.3% today to 15.5% in 3 years time.
• The bullish analysts expect earnings to reach $1.4 billion (and earnings per share of $0.31) by about December 2028, up from $318.0 million today. However, there is some disagreement amongst the analysts with the more bearish ones expecting earnings as low as $905.0 million.
• In order for the above numbers to justify the price target of the more bullish analyst cohort, the company would need to trade at a PE ratio of 11.2x on those 2028 earnings, down from 32.2x today. This future PE is lower than the current PE for the GB Metals and Mining industry at 21.8x.
• The bullish analysts expect the number of shares outstanding to decline by 0.47% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.02%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Structural power and water constraints in Southern Africa, including the uncertainty of electricity supply to Mozal Aluminum and the need to renegotiate power contracts at Hillside, could force curtailments or care and maintenance decisions that reduce aluminum production volumes and raise energy costs, pressuring revenue and net margins.
• Execution and cost overrun risk at major growth projects such as Hermosa’s Taylor and Peake deposits and the proposed fourth grinding line at Sierra Gorda, particularly in an environment of potential U.S. tariffs and construction inflation, could erode the expected return on growth capital and delay the uplift in group earnings.
• Ageing, technically complex legacy assets like Cannington and GEMCO, which now require more stopes, paste fill and mine plan redesigns and depend on uncertain reserve extensions from new leases, may face higher sustaining capital and unit costs over time, limiting free cash flow generation and compressing operating margins.
• Increasing competition and longer development timelines in global base metals exploration, including in remote or sensitive jurisdictions such as the Ambler district, Namibia and Botswana, raise the risk that South32’s pipeline of copper and zinc options matures more slowly than anticipated, constraining long term volume growth and future revenue diversification away from more cyclical bulk commodities.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bullish price target for South32 is A$4.17, which represents up to two standard deviations above the consensus price target of A$3.34. This valuation is based on what can be assumed as the expectations of South32's future earnings growth, profit margins and other risk factors from analysts on the bullish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of A$4.23, and the most bearish reporting a price target of just A$2.54.
  
• In order for you to agree with the more bullish analyst cohort, you'd need to believe that by 2028, revenues will be $9.0 billion, earnings will come to $1.4 billion, and it would be trading on a PE ratio of 11.2x, assuming you use a discount rate of 8.0%.
  
• Given the current share price of A$3.43, the analyst price target of A$4.17 is 17.7% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.