South32's management is responding well to the difficult conditions. They provided 5 specific examples of the operational measures they are taking at their mines, resulting in a meaningful reduction in cost per unit (lb or tonne etc). We consider South32's operational response to the extended downturn in commodity prices as very sound. At a company level, it is now expected the company will significantly exceed its $350m cost saving target in both quantum and timing.
On an underlying basis, South32 made a slight profit, but with a significant drop in earnings as compared to the proforma pcp (driven by the decline in commodity prices).
Furthermore, South32 achieved US$286m net debt reduction in H1. Debt was US$116m at 31-Dec-15 (and US$36m at 31-Jan-16). This was assisted by strong free cash-flow: US$192m for the half.
The downside of the result was what we see as the lack of vision for the future. As discussed above, BHP is staring to look at opportunities now, which will set it for the future. South32 rightly stated that balance sheet liquidity is a priority (as it rightly should be). And the balance sheet should be, and is, stress tested to ensure the company's robustness. However, we consider South32 has balance sheet capacity and robustness, and we would welcome the company pursuing attractive growth opportunities for the future (for instance, cost curve top quartile, where the company is able to apply its operational optimisation capabilities, where the is not significant downside risk, but also considerable upside when prices do recover).
That said, we consider South32 to be keenly priced currently, and the company has significant leverage (positive) to a commodity prices recovery. Therefore, we are comfortable holding it on a medium-term view.