Last week, BMO Capital Markets initiated coverage of BHP Billiton (LSE: BLT) spin-off South32 (LSE: S32), commenting that the shares of the newly created mining company “represent a more compelling investment than BHP Billiton at current price levels, after considering differences in commodity exposure valuation, cash generation potential, and future growth opportunities.”
The “key attraction” to South32, BMO analysts Edward Sterck and Alexander Pearce explained to clients in a lengthy research note, is its free cash generation potential, which they estimate will reach US$1 billion in fiscal 2016, for a yield of 11%. BMO forecasts that the company will generate “more than US$0.8 billion of net free cash flow (i.e. cash flow before debt movements and dividends) in fiscal 2015, rising to US$1.6 billion in fiscal 2018, for a net free cash flow yield of 10% to 19%, respectively.”
Other positives, the BMO analysts said, include a strong balance sheet with net debt of just US$0.7 billion, and “the potential for some M&A interest,” based on a Bloomberg report that the company could be of interest to Mick Davis’s X2 Resources. “Buying S32 would certainly provide a shortcut as X2 attempts to build a new mid-tier mining company,” Sterk and Pearce wrote.
The negatives, they said, are its “significant sensitivity to commodity price contractions” and particularly to aluminum (they calculated that a 10% drop in the price of aluminum reduces South32’s earnings before interest, taxes, depreciation and amortization (EBITDA) by about 8%), its low dividend yield of 3.4% in fiscal 2016, and its average return on invested capital (ROIC).
The BHP spin-off headquartered in Perth, Western Australia, has a market cap of US$9.6 billion and “is one of the most ‘diversified’ of the large cap miners in terms of commodity exposure, second only to Anglo American,” the BMO report states.
Read the complete article NorthernMiner.com/news/south32