Deutsche Bank starts South32 at 'hold', while Jefferies rates it at 'buy'

Deutsche Bank commenced coverage on BHP Billiton's spin-off South32 with a 'hold’ rating and 126p target.

“The listing of South32 has created a $10bn diversified global mid-cap miner with a strong balance sheet and reasonable cash flow from what we think is a mixed asset base,” said Deutsche.

The bank reiterated its views that growth and cost-cutting opportunities are limited, capex will climb in South Africa, copper production is falling and the South African assets are facing numerous headwinds.

As a result, commodity prices, fixed cost reductions and currency depreciation must drive earnings growth, said Deutsche.

“The two areas of upside are cost-cutting and mine-life extensions - we expect cost cutting to be management's focus over the next 12 months,” it added.

The bank is positive on the medium-term outlook for the majority of South32’s commodities, with the exception of manganese and coal, and forecasts earnings to double over the next five years.

“The key driver of the earnings uplift is from the lift in our alumina and aluminium prices and the fall in our currency forecasts,” said Deutsche concluded.

Jefferies also initiated coverage on the stock on Tuesday, with a 'buy' rating and 145p price target.

It also pointed to S32's strong balance sheet and said that this, along with the solid free cash flow, justifies a 'buy' rating despite the lack of organic growth.

Jefferies said that the shares should benefit from South32’s unique position in the markets as a midcap diversified miner, with low financial leverage, no exposure to iron ore and a management team that is starting with a clean slate. “These are significant positives,” it added.

Like Deutsche Bank, Jefferies noted that higher commodity prices will be a key driver of growth at S32.

"S32's production and earnings per share should be roughly flat over the next five years, but we estimate that its 2015-2025 volume compound annual growth rate will be be negative 2.4% as production sharply declines after 2020,” said Jefferies.
"Management may have some low hanging fruit cost cutting opportunities, but without volume growth, S32 is mostly
dependent on higher commodity prices to drive meaningful EPS growth and capital returns."

Finally, Jefferies added that in light of its strong FCF and balance sheet, combined with its limited organic growth potential,S32 is likely to pursue M&A opportunities in manganese, coal and copper.