HSBC upgrades South32 to 'buy' on expectations of share buyback

Shares in South 32 were on the front foot on Wednesday after HSBC upgraded the base metal and coal miner to 'buy' from 'hold' and left its price target unchanged at 185p, following suggestions that it will execute a share buyback programme in the first half.

HSBC believes that the Australian miner is likely to pursue a share buyback rather than distribute excess cash in is special dividend as it has not built up sufficient franking credits Down Under.

South32 told HSBC that the company would not necessarily wait until the end of the financial year to execute potential cash returns, and so the bank believes that the company will likely have $1bn of net cash from the $467m it currently has before end of June given the $200m working capital unwind and payment of dividends from Samancor, its manganese ore joint venture.

HSBC said that it was unsure of the quantum of the probable buyback but expects it to be at least $200m, which is broadly similar to the interim dividend of $192m.

On 27 February, South32 said its top priorities were to gain cash to invest in maintaining the integrity of the business by sustaining capital expenditure and to uphold its credit rating by ensuring the balance sheet remains robust with a net cash balance of $500m held through-the-cycle after dividends at the current 40% pay-out ratio.

The miner added that any excess cash beyond this would compete between a few internal projects, mergers and acquisitions and cash returns to shareholders through either dividends or share buybacks.

The bank said that the downside risks to South32 include weaker-than-expected commodity prices as the dollar stays stronger post-Brexit, the inability to deliver targeted cost savings and potentially value-destructive mergers and acquisitions.

Separately, South 32 is currently concerned over the lack of consultation with South Africa’s Department of Mineral Resources regarding potential changes to the country’s mining charter and it is also working with Australia’s regulator to address competition concerns over the acquisition of Peabody Energy's Metropolitan coal mine for $200m, with the deal expected to close by the end of the 2017 financial year.

London-listed shares in South32 were up 4.74% to 160.25p at 0930 GMT.