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South32 breaks free

The South32 iceberg is finally adrift in the southern latitudes, allowing the slimmed down BHP Billiton to concentrate its effort on its core commodities.

A swarm of analysis has surfaced on South32 and unsurprisingly, given the huge corporate effort by BHP, the consensus view on South32 is quite uniform.

What is rather surprising is the views on the new BHP are fairly disparate.

Target prices placed on South32 are in a tight range from $2.40-$2.70 with most clustering around $2.50 per share.

The discussion on the company centres on the cost-out opportunity, a conservative balance sheet, no iron ore, modest volume growth but upside exposure to recovering commodity prices.

South32 is no minnow with a market capitalisation of approximately $11.6 billion and no debt but it does carry a rehabilitation liability of $1.5 billion. The temptation to make acquisitions must also be apparent but if that distraction can be avoided, the company has an obvious profit growth pathway by reducing the cost base and improving productivity from its asset base

The demerger story was also pumped up by the potential for a good dividend yield with a minimum distribution of 40% of underlying earnings. Franking credits will need to be built up over time. The initial yield therefore looks a little skinny but should eventually become more attractive.

It is clear that UK owners of BHP stock do not generally want to own South32 as the first day of trading made evident.

The assets now owned by South32 range from South African coal to Australian coal, manganese and aluminium plus a grab-bag of other assets. The BHP results always focused on the big divisions so commentary on the South32 assets seldom received much attention from the market. That should change now but whether it will excite investors is open for debate.

While the South32 float has come and gone without too much fanfare, the discussion on the new BHP has been oddly mixed. Price targets on the new BHP have shot-gunned from $27-$34 per share depending on analyst views of the iron ore and oil price volatility.

BHP’s evolving view on its US shale assets and the uncertainty resulting from the slowing rate of economic growth in China may have something to do with the diversity of opinion. If the South32 demerger was designed to enable a cleaner focus on a core portfolio of high value commodities, BHP would be miffed that its share price hasn’t budged.

There is some analysis in the market suggesting that demergers are generally beneficial for both parent and pup, over time. Let’s not get carried away with that thinking lest someone raise the subject of Bluescope Steel and OneSteel (now Arrium) although these were both more than a decade ago.

BHP may be a little less enthusiastic about its shale oil assets in the US these days, but it is certainly thinking with more clarity about its conventional oil and gas prospects. It has a strong portfolio in that regard and could even contemplate acquisitions as and when opportunities present.

BHP’s oil and gas boss Tim Cutt noted recently that global exploration over the last two decades had only found about half of world oil consumption and this level had dropped dramatically to about one-fifth of consumption last year.

The global oil industry is a complex beast of politics, production and consumption, but this trend appears unsustainable.

It’s probably worth giving each company some breathing space to allow the demerger scenario to play out. The caveat, of course, is what will happen to the relevant commodity prices for each stock. Don’t expect miracles any time soon.

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