South32 arrives with focus on yield

BHP Billiton's (BHP) new baby South32 (S32) has been christened, having commenced trading on the Australian Securities Exchange. With the much heralded listing several brokers step up to initiate coverage of the stock. At this stage, there are three Buy ratings on the FNArena database with a consensus target of $2.62, suggesting 15.0% upside to the last share price.

South32 is a diversified miner, primarily exposed to aluminium and alumina, but spread across geographies, mainly Australia, Brazil and South Africa. Other commodity exposures include manganese, nickel, thermal & coking coal, silver, lead and zinc.

Three attributes stand out for JP Morgan: valuation, management and gearing. More than half of the broker's earnings estimates are driven by aluminium and alumina, with the remainder split between manganese, coal and other base metals. Six assets derive around 75% of the broker's valuation. These are Cannington, Illawarra, Alumar, Worsley, Hillside and Groote Eylandt (GEMCO).

JP Morgan considers these businesses well placed on the cost curve with cost-saving opportunities and incremental production growth. Low gearing sets the base for growth and shareholder returns. The broker expects the pay-out ratio will climb to 50% in FY16.

Earnings are likely to be volatile but then this makes South32 leveraged to any improvement in global economic activity. Yield is the main focus at present and this is attractive, at around 5.0% on the broker's FY16 estimates based on a 40% pay-out ratio.

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