Given the firm comes to market with a portfolio of assets that, while certainly at the lower end of the cost curve, produce assets that are currently rather unloved, it is unsurprising the listing didn’t capture the imagination of the investing public – especially a public that has been rather down on mining for a while.
As Liberum explained in a note on the listing, the firm faces some significant headwinds, not least of which are a number of structural issues surrounding aluminium, coal and manganese.
“Chinese policy around aluminium exports and a potential reversal of the Indonesian ore export ban could have long-term implications for aluminium and alumina prices,” Liberum said, while “China continuing to slow imports of coal (both thermal and coking) to protect the domestic industry removes a significant portion of seaborne demand. Negative steel production (yoy) from the Chinese industry impacts manganese demand, with c.55% of seaborne manganese going into China.”
Adding to its unattractiveness in the short term, Liberum said, are both its targeted payout ratio and the overarching commodity supply story.
“Investors want exposure to either a safe and reliable dividend or a supply led commodity story. Based on its targeted payout ratio we think South32 will be paying a sub-market dividend (certainly sub-mining sector) and for the reasons described above, its difficult to come up with a solid medium-term commodity story.”
Alasdair Mundy, head of the value team at Investec Asset Management said on Friday, ahead of the listing that the academic evidence for demergers and spin offs is interesting because, “very simply, they work for shareholders”.
Speaking on the Brewin Dolphin podcast, he said of spun out firms: “They tend to come out of much larger companies, they tend to be unloved, which is why they are being spun off, perhaps underinvested in, and, perhaps, the management team hasn’t been particularly well incentivised and that just gives you great opportunities. And, often, as an outsider, you can’t see the opportunity is there.”
Indeed, this is very much the thrust of BHP Billiton’s argument for the demerger. In its last demerger roadshow presentation, the firm argued that: the cost of spinning out the business and setting up the new corporate centre would be offset by the cost savings made by the creation of a new, leaner, regional management structure.
Of course, it will only be in time that this particular silver, aluminium, coal and manganese infused pudding will be able to provide any proof of this theory, but there are a number of previous examples, such as DirectLine to which one can point, where significant value has been created.
But, while the outlook for many commodities remains uncertain, perhaps an even bigger question than how what is now the world’s largest manganese miner is going to fare, is: what does the market’s lacklustre reception mean for the prospect of further M&A activity among the mega-caps?
For Mundy the prospects are rather good, even if the South32 listing is ignored.
“With very large companies having run into quite a few problems in the last few years, we wouldn’t be surprised to see some more demerges and spin offs from the banks, pharmaceuticals and the mining companies over the next few years,” he said.
“In the 1990s these very large companies all went off on acquisition sprees in pharma, oil and banking in particular and as soon as one does they all feel like they have to follow suit to maintain their relative sizes. So they all became even larger and more unmanageable,” he added.
Now, however, far from looking the staid, bloated companies that investors have begun to see them as, Mundy believes that management now has the potential to add value, by stripping away the fat from what he sees as “very interesting core business that haven’t been looked after in the past decade”.
Charles Long, manager of the GLG UK Select Fund has also begun to take a closer look at the megacap resources sector as management has become more aggressive and proactive in its style.
“We are pleased to see much more aggressive actions from commodities businesses, from a micro perspective we like what management is doing. On top of that earnings momentum has improved as prices have rallied somewhat. We think we have now seen the inflection point in earnings momentum,” Long told Portfolio Adviser last week.
By nature, Mundy is a contrarian investor, so he is quite happy on what many view as the wrong side of the trade, but there is definitely a growing view that perhaps megacaps and particularly those in the resources sector are no longer quite the pariahs that they perhaps once were. And, that we could well see further corporate action as management teams look to better unlock value.
