Market Update – BHP / South32

Monday, May 18 2015

In August last year, BHP proposed the demerger of its non-core mines. The rationale was so BHP could focus more effectively on what it saw as its four key pillars being coal, iron ore, copper and petroleum. On Wednesday shareholders in BHP voted to approve the spinoff of these assets, which include manganese, aluminium, silver, lead and zinc that will soon trade on the ASX under the name South32. As a result, on 18 May existing BHP shareholders will receive 1 share of the new company for every 1 share of BHP held. While BHP’s share price will roughly decrease by the value of the new share issued, accordingly BHP’s weight in the Australian index will decrease.

As part of our research we attended a tour of the Australian assets last week which included trips to Wollongong, Cairns and Townsville as well as remote areas in Western Australia and the Northern Territory. The tour highlighted that these ‘non-core’ assets were still high quality. While other notable features included:

  • Cost outs—Management are in agreement that the cost base is inflated with headcount and productivity gains to be had.
  • Resource to reserve conversion—While the assets have been well maintained, development spend on extending mine lives has been minimal resulting from competition for capital amongst other BHP projects.
  • Management and cultural changes—South32 will run under a regional model essentially removing a layer of middle management. Additionally a more entrepreneurial culture shift is being pushed across the business with the aim of moving away from BHP’s rigid structures.

Manganese Stockpiles ready to be shipped from port
Groote Eylandt, Northern Territory

news 20150518 BHP South32

Source: Dalton Nicol Reid

Along with these bottom-up factors we think that over the medium term South32 also has some favourable macro drivers. Its overall commodity exposures are less reliant on emerging market growth, in an environment where green shoots are emerging in developed economies. Additionally the company will start life with a strong balance sheet, which enables it to weather short term commodity fluctuations and make opportunistic acquisitions of distressed mines. The key negative is that these commodities will be volatile and the share price will also be volatile and trade in line with expectations for global growth.

Internally we used a discounted cash flow model which values South32 at $2.74 which we believe is fair value. Therefore depending on the opening price we may look to opportunistically add to our position below $2.20 as our expectation is that over the very short term UK investors in BHP will be forced sellers as the stock will not be included in the major European indexes. On the other hand we are aware South32 is a potential takeover target with possible suitors that could be prepared to pay a premium for the stock. If this was the case we would prudently look to lighten our position and take some profits.

This document has been prepared by Dalton Nicol Reid Ltd, AFS Representative - 294844 of DNR AFSL Pty Ltd ABN 39 118 946 400, AFSL 301658. It is general information only and is not intended to be a recommendation to invest in any product or financial service mentioned above. Whilst Dalton Nicol Reid has used its best endeavours to ensure the information within this document is accurate it cannot be relied upon in any way and recipients must make their own enquiries concerning the accuracy of the information within. The general information in this document has been prepared without reference to any recipients objectives, financial situation or needs. Before making any financial investment decisions we recommend recipients obtain legal and taxation advice appropriate to their particular needs. Investment in a Dalton Nicol Reid individually managed account can only be made on completion of all the required documentation.
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