South32 Regulatory News (S32)

South32 Limited

(Incorporated in Australia under the Corporations Act 2001)

(ACN 093 732 597)

ASX / LSE / JSE Share Code: S32 ADR: SOUHYISIN: AU000000S320

south32.net

South32 Limited

Financial Results and Outlook Half Year Ended 31 December 2017

Restructuring our portfolio and delivering strong shareholder returns

"After a challenging start to the 2018 financial year, production for the majority of our operations is tracking on or ahead of schedule. We achieved record production at Australia Manganese and Mozal Aluminium, increased production guidance at South Africa Manganese in response to favourable market conditions, and delivered a 23 per cent increase in payable nickel production at Cerro Matoso as ore grades improved.

"We also announced a 4.3B South African rand investment in the Klipspruit colliery, which will extend its life by approximately 20 years, and our decision to manage South Africa Energy Coal as a stand-alone business to sustainably improve its financial performance. This major strategic initiative will also allow us to transform the ownership of South Africa Energy Coal, consolidate our functions and further reduce duplication.

"We continue to deliver strong returns by maintaining a disciplined and flexible approach to capital management. We resolved to pay US$378M in shareholder dividends, directed US$93M to our buy-back program and announced a further US$250M increase to our capital management program to US$1B, leaving US$540M outstanding.

"With a net cash balance of US$1.4B, working capital expected to partially unwind and Group volumes expected to increase marginally in the second half, we are well positioned despite a reduction in future Cannington processing rates and metal production."

Graham Kerr, South32 CEO

december 2017 halF year SUMMARY

SAFETY

Nothing is more important to us than creating an environment where everyone goes home safe and well every day. Through our Care Strategy we are building an inclusive workplace with a strong culture of care and accountability, where work is well-designed and we continuously improve and learn. Our Total Recordable Injury Frequency (TRIF(9)(10)) declined from 6.0 to 4.9 per million hours worked in H1 FY18.

PERFORMANCE HIGHLIGHTS

In H1 FY18 we delivered a statutory profit after tax of US$543M as stronger commodity prices more than offset lower volumes and broader inflationary pressure, most notably in our aluminium supply chain. Production guidance is unchanged for the majority of our operations and Group volumes are expected to increase marginally in H2 FY18. With a net cash balance of US$1.4B and working capital expected to partially unwind, we are well positioned despite a reduction in future Cannington processing rates and metal production.

Specific performance highlights included:

South Africa Energy Coal separation update

On 27 November 2017, we announced that we would manage South Africa Energy Coal as a stand-alone business in order to sustainably improve its financial performance and that we would simplify the way we manage the remainder of our global portfolio. We are well advanced in our planning of this important strategic initiative and propose to implement this new way of working during H2 FY18, unlocking additional value for shareholders. 

With the management of South Africa Energy Coal as a stand-alone entity, we propose to consolidate our functions across the Group. Removing our regional structures will allow us to have more direct lines of communication, streamline our processes and further reduce duplication.

This new way of working will also include:

We are currently finalising plans and will be commencing consultation with employees and key stakeholders. A further update will be provided during H2 FY18.

EARNINGS

The Group's statutory profit after tax decreased by US$77M (or 12%) to US$543M in H1 FY18. The corresponding period's profit benefitted from the recognition of a fair value gain on non-trading derivative instruments of US$189M.

Consistent with our accounting policies, various items are excluded from the Group's statutory profit to derive Underlying earnings including: exchange rate losses associated with the restatement of monetary items (US$17M pre-tax); fair value losses on non-trading derivative instruments (US$65M pre-tax); exchange rate losses associated with the Group's non US dollar denominated debt (US$11M pre-tax); the tax expense for all pre-tax earnings adjustments and exchange rate variations on tax balances (-US$61M) and significant items (-US$31M). Further information on these earnings adjustments is included on page 38.

Underlying EBITDA increased by US$23M (or 2%) to US$1.1B for an operating margin of 35.7% in H1 FY18(H1 FY17: 36.7%). Higher realised prices for most of our commodities during the period gave rise to a US$273M increase in sales revenue, despite a significant reduction in coal and metal production at Illawarra Metallurgical Coal and Cannington, respectively. The Group's cost base was primarily impacted by external inflationary pressures such as a stronger Australian dollar and South African rand, higher price-linked royalties and rising raw material input costs. The latter pressure was most notable in our aluminium supply chain as higher caustic soda, energy, coke, pitch and alumina prices reflected more buoyant commodity markets. Our operating leverage and long alumina position ensures we are a net beneficiary of this dynamic.

Underlying EBIT increased 5% to US$724M, benefitting from a reduction in depreciation and amortisation. Underlying earnings increased 14% to US$544M.

Earnings Analysis

The reconciliation of movements in Underlying EBIT graph can be found within the National Storage Mechanism version of the release.

The following key factors influenced Underlying EBIT in H1 FY18, relative to H1 FY17.

Net finance cost

The Group's Underlying net finance cost, excluding equity accounted investments, was US$59M in H1 FY18 and largely reflects the unwinding of the discount applied to our closure and rehabilitation provisions (US$52M) and finance lease interest (US$27M), primarily at Worsley Alumina.

Tax expense

The Group's Underlying income tax expense, which excludes tax associated with equity accounted investments, was US$121M for an Underlying effective tax rate(14) (ETR) of 28.0%. The Group's Underlying ETR largely reflects the geographic distribution of the Group's profit. The corporate tax rates applicable to the Group include: Australia 30%, South Africa 28%, Colombia 40%, Mozambique 0%(15) and Brazil 34%.

The tax expense for equity accounted investments was US$137M, including royalty related taxation of US$31M at GEMCO, for an ETR of 36.2%.

CASH FLOW

The Group's free cash flow from operations, excluding equity accounted investments, was US$52M in H1 FY18. Stronger prices for our commodities and higher raw material inputs contributed to a build in working capital (+US$421M), while the lagged effect of higher profitability in FY17 fed through to a significant increase in income tax payments (+US$142M to US$181M, net, excluding tax paid within equity accounted investments).

Trade and other receivables increased by US$223M as days debtors temporarily rose to 25 days at 31 December 2017 (18 days as at 30 June 2017). This receivables balance is expected to partially unwind with days debtors projected to decline towards the typical 20 days as there has been no change to customer payment terms. The temporary increase in days debtors at period end primarily related to high value aluminium sales being concluded at the end of December.

The US$172M increase in the value of inventory held (primarily aluminium and metallurgical coal) reflects higher raw material input costs in our aluminium supply chain and a temporary increase in finished goods at some operations.

The prior weather related deferral of activity at South Africa Energy Coal contributed to a US$50M increase in total capital expenditure(16), excluding equity accounted investments, to US$202M. This included:

The purchase of intangibles and the capitalisation of exploration accounted for a further US$3M of expenditure.

Total capital expenditure associated with equity accounted investments increased by US$10M to US$29M duringH1 FY18 as we invested in additional tailings storage capacity at Australia Manganese.

Total capital expenditure, including equity accounted investments, was US$231M in H1 FY18.

We received (net) distributions totalling US$238M from our manganese equity accounted investments in H1 FY18, comprising US$70M in dividends and US$168M from the repayment of a shareholder loan. A further US$9M in dividends was received from our other investments, including Mineração Rio do Norte S.A (MRN).

Balance sheet, dividends & CAPITAL MANAGEMENT

As at 31 December 2017, the Group's net cash balance was US$1.4B, following the payment of our US$333M final dividend in respect of FY17 and the purchase of a further 37M shares for a cash consideration of US$93M during H1 FY18.

With our focus on value rather than execution speed we slowed the rate of our on-market buy-back during H1 FY18. To 31 December 2017 we have purchased 143M shares at an average price of A$2.80 per share for a cash consideration of US$305M.

Demonstrating the disciplined and flexible approach we are taking with our capital management program and our confidence in our financial position, our Board has resolved to pay a fully franked interim dividend of US$223M, representing 41% of Underlying earnings in H1 FY18 and a partially franked (to 81%) special dividend of US$155M.

Notwithstanding this 97% increase in dividend distributions, we have also increased our approved capital management program by a further US$250M to US$1B, leaving US$540M to be returned before the end of April 2019.

Consistent with our commitment to maintain a strong investment grade credit rating, Standard and Poor's and Moody's reaffirmed their respective BBB+ and Baa1 credit ratings for the Group having completed their annual reviews in H1 FY18.

South32 Limited shareholders registered on the South African branch register will not be able to dematerialise or rematerialise their shareholdings between 7 and 9 March 2018 (both dates inclusive), nor will transfers to/from theSouth African branch register be permitted between 1 and 9 March 2018 (both dates inclusive).

Details of the currency exchange rates applicable for the dividend will be announced to the relevant stock exchanges. Further dividend information is available on our website (www.south32.net).

South32 American Depositary Receipts (ADRs) each represent five fully paid ordinary shares in South32 and ADR holders will receive dividends accordingly, subject to the terms of the Depositary Agreement.

outlook

Production

FY18 production guidance is unchanged for the majority of our operations with Group volumes expected to increase marginally in H2 FY18. Production at South Africa Manganese is expected to be 8% higher than our initial estimate as market conditions for manganese remain strong. At Cannington, the stress regime is evolving as the orebody is being depleted and we are moving to more challenging areas within the mine plan. In order to deliver greater predictability and stability in the underground mine as the level of activity increases (80 stopes to be extracted in FY19, average of 50: FY12-16), we are lowering the mining rate to 2.45 Mt per annum which is expected to translate to mill throughput of 2.3Mt and 2.4Mt in FY18 and FY19, respectively. FY18 production guidance and our forward plan for Illawarra Metallurgical Coal remains unchanged. We will run a single longwall at Appin for the remainder of FY18 as part of a staged ramp-up of activities, before targeting a return to a twin longwall configuration in the December 2018 quarter. We will provide FY19 production guidance for Illawarra Metallurgical Coal with our FY18 results to reflect the completion of our annual planning cycle.

The denotation (e) refers to an estimate or forecast year.

Costs and Capital expenditure

Industry cost curves steepened during H1 FY18 as a result of US dollar weakness, rising commodity prices and the environmental policy response in China. Despite a strong focus on controllable costs, all of our operations are being affected by these external factors to some degree with the pressure being most notable in our smelters and refineries (caustic soda, alumina, price-linked power, pitch and coke).

Operating unit costs

(a) Adjusted H1 FY18 Operating unit costs are restated to reflect price and foreign exchange rate assumptions used for Prior FY18 guidance (refer to footnote 19).

(b) Prior FY18 Operating unit cost guidance includes commodity price and foreign exchange rate forward curves or our internal expectations (refer to footnote 19).

(c) US dollar per tonne of ore processed. Periodic movements in finished product inventory may impact operating unit costs as related marketing costs and treatment and refining charges may change.

Operating unit cost guidance

We have updated our FY18 operating unit cost guidance by operation to primarily reflect the movement in underlying exchange rate and price assumptions.

(a) Prior FY18 Operating unit cost guidance includes commodity price and foreign exchange rate forward curves or our internal expectations (refer to footnote 19).

(b) Adjusted FY18 Operating unit cost guidance is Prior FY18 Operating unit cost guidance, restated to reflect price and foreign exchange rate assumptions used for New FY18 Operating unit cost guidance (refer to footnote 20).

(c) New FY18 Operating unit cost guidance includes commodity price and foreign exchange rate forward curves or our internal expectations for the remainder of FY18, as at January 2018 (refer to footnote 20).

(d) US dollar per tonne of ore processed. Periodic movements in finished product inventory may impact operating unit costs as related marketing costs and treatment and refining charges may change.

Other expenditure guidance

Corporate costs of US$105M are now expected in FY18, an increase of US$25M relative to prior guidance to reflect a greater rate of investment in technology in support of our operations and a rise in greenfield exploration activity (+US$5M to US$25M).

Depreciation and amortisation (excluding equity accounted investments) of US$730M is now expected in FY18. The US$30M reduction in guidance primarily relates to Illawarra Metallurgical Coal, where extraction and development rates have been reset as a result of the extended outage at the Appin mine. Depreciation and amortisation guidance for our equity accounted investments of US$85M is unchanged.

Capital expenditure guidance

We have lowered FY18 guidance for Sustaining capital expenditure, including equity accounted investments, by US$5M to US$465M. This minor adjustment reflects a further reduction in expenditure at Illawarra Metallurgical Coal (-US$15M to US$105M) and incrementally lower expenditure across the portfolio, which is partially offset by a higher rate of investment at South Africa Energy Coal (+US$20M to US$132M) and revised exchange rate assumptions. This guidance excludes Major project capital expenditure for the 4.3B rand South Africa Energy Coal KPSX project, which was approved in November 2017. Major project capital expenditure guidance for FY18 has been increased by US$10M to US$60M to reflect the timing of a number of long lead time items and revised exchange rate assumptions.

The denotation (e) refers to an estimate or forecast year.

operations Analysis

A summary of the underlying performance of the Group's operations is presented below. Unless otherwise stated: all metrics reflect South32's share; Operating unit cost is Revenue less Underlying EBITDA excluding third party sales divided by sales volumes; and Operating cost is Revenue less Underlying EBITDA excluding third party sales.

(a) Revenue and Underlying EBIT reflect South32's proportionally consolidated interest in the manganese joint venture operations.

(b) The equity accounting adjustment reconciles the proportional consolidation of the South32 manganese operations to the treatment of the manganese operations on an equity accounted basis.

Worsley Alumina (86% SHARE)

Volumes

Worsley Alumina hydrate production was largely unchanged at 1.95Mt in H1 FY18 as the refinery's input circuit continued to operate at a rate of 4.5Mtpa (100% basis). In contrast, calcined alumina production declined by 4% (or 75kt) to 1.87Mt in H1 FY18 as scheduled maintenance was undertaken and a substantial hydrate inventory position was established.

FY18 production guidance remains unchanged at 4.0Mt with additional calciner maintenance scheduled for the March 2018 quarter.

Operating costs

Operating unit costs increased by 12% to US$224/t inH1 FY18 as the price of caustic soda increased, consumption rates rose temporarily and the Australian dollar strengthened.

We have updated FY18 unit cost guidance to US$235/t to reflect revised exchange rate and price assumptions, and a significantly higher price of caustic soda, albeit caustic consumption is expected to decline in H2 FY18 with the introduction of bauxite feed from West Marradong. Exchange rate and price assumptions for FY18 unit cost guidance are detailed in footnote 20.

Financial performance

Underlying EBIT increased by 531% (or US$138M) in H1 FY18 to US$164M as a 37% rise in the average realised price of alumina (+US$184M) was partially offset by an increase in the price of caustic soda and caustic consumption rates (-US$39M), and a stronger Australian dollar (-US$8M).

Capital expenditure

Sustaining capital expenditure increased to US$22M in H1 FY18. Expenditure in H2 FY18 will be primarily directed towards bauxite residue disposal capacity and boiler maintenance.

(a) Realised sales price is calculated as sales revenue divided by sales volume.

(b) Operating unit cost is Revenue less Underlying EBITDA divided by sales volume.

(a) H1 FY17 reflects balance as at 30 June 2017.

South Africa Aluminium (100%)

Volumes

South Africa Aluminium saleable production increased by 1% (or 2kt) to 358kt in H1 FY18 and remains on track to increase in FY18 despite an electric arc incident on 30 November 2017 which impacted 39 pots. These pots are being progressively returned to service during the March 2018 quarter. A temporary increase in finished goods inventory related to our shipping schedule is expected to unwind in H2 FY18.

FY18 production guidance remains unchanged at 720kt.

Operating costs

Operating unit costs increased by 22% to US$1,680/t in H1 FY18 as higher raw material input costs for alumina, coke and pitch, and higher aluminium price-linked electricity costs for the smelter were absorbed. This rise in raw material costs and the stronger aluminium price contributed to a significant increase in the value of inventory.

A total of 44 pots were relined across H1 FY18 at a cost of US$196k per pot (H1 FY17: 50 pots at US$211k per pot). 145 pots are scheduled to be relined in FY18.

While operating unit cost guidance is not provided, the cost profile of the smelter will continue to be heavily influenced by power and raw material inputs, given the operation's high variable cost base. Hillside sources power from Eskom under long-term contracts with the price of electricity supplied to potlines 1 and 2 linked to the LME aluminium price and the South African rand/US dollar exchange rate. The price of electricity supplied to potline 3 is South African rand based.

Financial performance

Underlying EBIT increased by 33% (or US$30M) in H1 FY18 to US$120M as a 23% increase in the average realised price of aluminium (+US$138M) was largely offset by an increase in raw material input costs (-US$81M) and aluminium price-linked electricity costs (-US$18M).

Capital expenditure

Sustaining capital expenditure increased to US$13M in H1 FY18 following a deferral of activity in FY17.

(a) Volumes and prices do not include any third party trading that may be undertaken independently of equity production. Realised sales price is calculated as sales revenue divided by sales volume.

(b) Operating unit cost is Revenue less Underlying EBITDA divided by sales volume.

(a) H1 FY17 reflects balance as at 30 June 2017.

Mozal ALUMINIUM (47.1% SHARE)

Volumes

Mozal Aluminium saleable production increased by 1% (or 1kt) to a record 137kt in H1 FY18 as the smelter continued to operate at its maximum technical capability. Aluminium sales increased by 10% as our inventory position returned to more normal levels, however the timing of those sales fed through to our receivables balance and an increase in average days debtors for the Group.

FY18 production guidance remains unchanged at 269kt.

Operating costs

Operating unit costs increased by 17% to US$1,694/t in H1 FY18 as the cost of raw material inputs (alumina, coke and pitch) increased.

A total of 34(22) pots were relined in H1 FY18 at a cost of US$191k per pot (H1 FY17: 39(22) pots at US$193k per pot). 82(22) pots are scheduled to be relined in FY18.

While operating unit cost guidance is not provided, the cost profile of the smelter will continue to be heavily influenced by power and raw material inputs, given the operation's high variable cost base. Mozal Aluminium utilises hydroelectric power that is generated by Hidroeléctrica de Cahora Bassa (HCB). HCB delivers power into the South African grid to Eskom and Mozal Aluminium sources electricity via the Mozambique Transmission Company (Motraco) under a long term contract. The price of electricity supplied is South African rand based with the rate of escalation linked to a South Africa domestic production price index plus margin.

Financial performance

Underlying EBIT increased by 140% (or US$35M) in H1 FY18 to US$60M as a 25% increase in the average realised price of aluminium (+US$65M) and higher sales volumes (+US$23M) were partially offset by higher alumina, pitch and coke input costs (-US$20M).

Capital expenditure

Sustaining capital expenditure increased to US$8M in H1 FY18. The US$18M AP3XLE energy efficiency project, which was approved in August 2017, remains on schedule with first incremental production anticipated in FY20 and the full benefit to be realised by FY24. The project will deliver a circa 5% (or 10kt pa) increase in annual production with no associated increase in power consumption.

(a) Volumes and prices do not include any third party trading that may be undertaken independently of equity production. Realised sales price is calculated as sales revenue divided by sales volume.

(b) Operating unit cost is Revenue less Underlying EBITDA divided by sales volume.

(a) H1 FY17 reflects balance as at 30 June 2017.

Brazil ALUMINA (ALUMINA 36% SHARE, ALUMINIUM 40% SHARE)

Volumes

Brazil Alumina saleable production increased by 3kt to 676kt in H1 FY18 as the refinery continued to operate at capacity.

FY18 production guidance remains unchanged at 1.3Mt with Phase I of the refinery de-bottlenecking project nearing completion.

Operating costs

Operating unit costs at the non-operated refinery increased by 21% to US$234/t in H1 FY18 as the price of caustic soda increased and consumption rates rose temporarily as lower quality bauxite feed was introduced following a weather related disruption to supply from MRN.

Financial performance

Alumina Underlying EBIT increased by 392% (or US$47M) in H1 FY18 to US$59M as a 44% increase in the average realised price of alumina (+US$73M) was partially offset by higher caustic soda (-US$9M) and fuel oil (-US$12M) costs.

Aluminium Underlying EBIT decreased by US$10M to a loss of US$12M as our obligation to purchase electricity from Eletronorte was fulfilled during the period, following termination of the contract in December 2015. The sale of surplus electricity generated other income of US$36M, although this was more than offset by the utilisation of the associated onerous contract provision and the recognition of a US$12M provision to reflect transmission charges that will no longer be offset by ongoing electricity purchases.

Capital expenditure

Sustaining capital expenditure decreased to US$10M in H1 FY18 with the de-bottlenecking Phase I project nearing completion.

(a) Realised sales price is calculated as sales revenue divided by sales volume.

(b) Operating unit cost is Revenue less Underlying EBITDA divided by sales volume.

(c) Includes cost of acquiring bauxite mainly from MRN.

(a) H1 FY17 reflects balance as at 30 June 2017.

South Africa Energy Coal (92% SHARE)

Volumes

South Africa Energy Coal saleable production decreased by 9% (or 1.4Mt) to 13.4Mt in H1 FY18. Export coal production exceeded expectations as productivity lifted at both the Klipspruit mine and the export oriented areas of the WMC. In contrast, domestic production was impacted by a reduction in demand from the Duvha power station and scheduled maintenance in the domestically focused areas of the WMC. The continued build of inventory across H1 FY18 reflects ongoing constraint in the supply chain and weather related delays at the Richards Bay Coal Terminal.

FY18 production guidance remains unchanged at 27.5Mt (11.5Mt export; 16.0Mt domestic).

Operating costs

Operating unit costs increased by 38% to US$36/t in H1 FY18 as the South African rand strengthened, the proportion of higher margin export tonnes (with associated washing and logistics costs) increased and an area of in-pit inventory at the WMC was written down to net realisable value.

We have updated FY18 unit cost guidance to US$34/t to reflect revised exchange rate and price assumptions. Exchange rate and price assumptions for FY18 unit cost guidance are detailed in footnote 20.

Financial performance

Underlying EBIT decreased by 10% (or US$13M) in H1 FY18 to US$115M. Higher average export (+US$77M) and domestic (+US$28M) realised prices were more than offset by lower sales volumes (-US$30M), an increase in planned maintenance and labour costs (-US$48M), inflation (-US$22M) and a stronger South African rand (-US$21M). The operation's costs were also impacted by the net realisable value write-down of an area of in-pit inventory at the WMC (-US$8M).

Capital expenditure

Sustaining capital expenditure increased to US$68M in H1 FY18 as activity previously deferred as a result of adverse weather was completed. Sustaining capital expenditure will continue to be directed towards the WMC in H2 FY18 given the requirement to open-up new mining areas. FY18 guidance for Sustaining capital expenditure has been increased by US$20M to US$132M.

We also invested US$4M in H1 FY18 to progress the 4.3B South African rand KPSX project, which was approved by the Board in November 2017. The 8Mtpa brownfield project will extend the life of the Klipspruit colliery by more than 20 years.

(a) South32's interest in South Africa Energy Coal is accounted at 100% until Broad-Based Black Economic Empowerment (B-BBEE) vendor loans are repaid.

(b) Volumes and prices do not include any third party trading that may be undertaken independently of equity production. Realised sales price is calculated as sales revenue divided by sales volume.

(c) Operating unit cost is Revenue less Underlying EBITDA divided by sales volume.

(a) South32's interest in South Africa Energy Coal is accounted at 100% until B-BBEE vendor loans are repaid.

(b) Includes domestic and export sales revenue.

(c) H1 FY17 reflects balance as at 30 June 2017.

Illawarra Metallurgical Coal (100%)

Volumes

Illawarra Metallurgical Coal saleable production decreased by 50% (or 1.9Mt) to 1.9Mt in H1 FY18 as the Appin colliery recovered from an extended outage and the Dendrobium longwall progressed through a faulted zone.

FY18 production guidance of 4.5Mt remains unchanged with a longwall move now scheduled for Dendrobium in the June 2018 quarter.

Operating costs

Operating unit costs increased by 99% to US$149/t in H1 FY18, commensurate with the significant reduction in coal sales.

We have updated FY18 unit cost guidance to US$135/t to reflect revised exchange rate and price assumptions. Exchange rate and price assumptions for FY18 unit cost guidance in footnote 20.

Financial performance

Underlying EBIT decreased by US$193M in H1 FY18 to a loss of US$84M as lower sales volumes (-US$258M) more than offset higher average realised coal prices (+US$36M), lower price-linked royalties (+US$15M) and a volume related reduction in depreciation (+US$14M).

Capital expenditure

Sustaining capital expenditure decreased by 17% to US$40M in H1 FY18 as underground development was impacted by the extended outage. FY18 guidance for Sustaining capital expenditure has been reduced by a further US$15M to US$105M to reflect a lower level of underground activity.

(a) Realised sales price is calculated as sales revenue divided by sales volume.

(b) Operating unit cost is Revenue less Underlying EBITDA divided by sales volume.

(a) Includes metallurgical coal and energy coal sales revenue.

(b) H1 FY17 reflects balance as at 30 June 2017.

Australia Manganese (60% SHARE)

Volumes

Australia Manganese saleable ore production increased by 13% (or 202kwmt) to a record 1.7Mwmt in H1 FY18. Lower than expected rainfall in the December 2017 quarter underpinned higher throughput in the primary circuit while favourable market conditions allowed the PC02 circuit to operate at full capacity. The PC02 circuit contributed 8% of total manganese ore production in H1 FY18 (5% H1 FY17; 6% FY17).

Saleable Manganese alloy production increased by 5%(or 4kt) to 82kt in H1 FY18.

FY18 ore production guidance remains unchanged at 3.1Mwmt with the wet season expected to impact production across H2 FY18.

Operating costs

FOB manganese ore operating unit costs increased by 8% to US$1.55/dmtu in H1 FY18 as a result of a rise in planned maintenance expenditure, a stronger Australian dollar and higher price-linked royalties.

We have updated FY18 unit cost guidance to US$1.63/dmtu to reflect revised exchange rate and price assumptions. Exchange rate and price assumptions for FY18 unit cost guidance are in footnote 20.

Financial performance

Underlying EBIT increased by 44% (or US$92M) in H1 FY18 to US$299M. A significant improvement in average realised ore and alloys prices (+US$106M) and an increase in sales volumes (+US$20M) were only partially offset by a rise in planned maintenance expenditure (-US$8M), the impact of a stronger Australian dollar and higher price-linked royalties (-US$7M).

Our average realised price for external ore sales in H1 FY18 reflected the high grade 44% manganese lump ore index (CIF China) on a volume weighted M-1 basis(23), despite the higher contribution of 40% grade PC02 product to the sales mix.

Capital expenditure

Sustaining capital expenditure increased to US$21M in H1 FY18 as we invested in additional tailings storage capacity at GEMCO.

(a) Volumes and realised prices do not include any third party trading that may be undertaken independently of equity production. Realised ore prices are calculated as external sales revenue less freight and marketing costs, divided by external sales volume. Realised alloy prices are calculated as sales revenue, including sinter revenue, divided by alloy sales volume. Ore converted to sinter and alloy, and sold externally, is eliminated as an intracompany transaction.

(b) H1 FY18 average manganese content of ore sales was 46.1% on a dry basis (H1 FY17: 46.4%). 94% of H1 FY18 external manganese ore sales (H1 FY17: 95%) were completed on a CIF basis. H1 FY18 realised FOB ore prices and operating unit costs have been adjusted for freight and marketing costs of US$21M (H1 FY17: US$13M), consistent with our FOB cost guidance.

(c) FOB ore operating unit cost is Revenue less Underlying EBITDA, freight and marketing costs, divided by ore sales volume. Alloy operating unit cost is Revenue less Underlying EBITDA divided by alloy sales volumes and includes costs associated with sinter sold externally.

(a) Revenues associated with sales from GEMCO to TEMCO are eliminated as part of the consolidation. Internal sales occur on a commercial basis.

(b) H1 FY17 reflects balance as at 30 June 2017.

South Africa Manganese (ORE 44.4% SHARE, ALLOY 60% SHARE)

Volumes

South Africa Manganese ore production increased by 21% (or 195kwmt) to 1.1Mwmt in H1 FY18 as the continuation of higher cost trucking and the sale of lower quality fines products enabled us to take advantage of favourable market conditions. FY18 ore production guidance has been increased by 8% to 2,040kwmt, but remains subject to market demand.

Manganese alloy saleable production decreased by 3% (or 1kt) to 36kt in H1 FY18 as Metalloys continued to operate one of its four furnaces.

Operating costs

FOB manganese ore operating unit costs increased by 18% to US$2.31/dmtu in H1 FY18 as a result of a stronger South African rand and higher price-linked royalties. The drawdown of low cost Wessels concentrate and other fines material stockpiles offset the cost of opportunistically trucking ore to port.

We have updated FY18 unit cost guidance to US$2.41/dmtu to reflect revised exchange rate and price assumptions, and a continuation of higher cost trucking activity. Exchange rate and price assumptions for FY18 unit cost guidance are in footnote 20.

Financial performance

Underlying EBIT increased by 87% (or US$40M) in H1 FY18 to US$86M as a significant improvement in ore and alloy prices (+US$49M) was only partially offset by a stronger South African rand (-US$5M), higher price-linked royalties (-US$4M) and an increase in trucking costs (-US$6M). 

Our average realised price for external ore sales in H1 FY18 reflected the medium grade 37% manganese lump ore index(24) on a volume weighted M-1 basis. Wessels concentrate and other fines products receive a substantial discount when referenced to index prices. Favourable negotiated price outcomes for our primary products and a temporary increase in the proportion of sales priced in the month of shipping (i.e. M, as opposed to M-1) offset the impact of these discounts.

Capital expenditure

Sustaining capital expenditure increased to US$8M in H1 FY18.

(a) Volumes and prices do not include any third party trading that may be undertaken independently of equity production. Realised ore prices are calculated as external sales revenue less freight and marketing costs, divided by external sales volume. Realised alloy prices are calculated as sales revenue, divided by alloy sales volume. Ore converted to sinter and alloy, and sold externally, is eliminated as an intracompany transaction. Manganese ore sales are grossed-up to reflect a 60% accounting effective interest.

(b) H1 FY18 average manganese content of ore sales was 40.3% on a dry basis (H1 FY17: 40.3%). 68% of H1 FY18 external manganese ore sales (H1 FY17: 61%) were completed on a CIF basis. H1 FY18 realised FOB ore prices and operating costs have been adjusted for freight and marketing costs of US$16M (H1 FY17: US$10M), consistent with our FOB cost guidance.

(c) FOB ore operating unit cost is Revenue less Underlying EBITDA, freight and marketing costs, divided by ore sales volume. Alloy operating unit cost is Revenue less Underlying EBITDA divided by alloy sales volumes.

(a) Revenues associated with sales from Hotazel Manganese Mines (HMM) to Metalloys are eliminated as part of the consolidation. Internal sales occur on a commercial basis.

(b) Consistent with the presentation of South32's segment information, South Africa Manganese ore production and sales have been reported at 60%. South32 has a 44.4% ownership interest in HMM. 26% of HMM is owned by a B-BBEE consortium comprising Ntsimbintle Mining (9%), NCAB Resources (7%), Iziko Mining (5%) and HMM Education Trust (5%). The interests owned by NCAB Resources, Iziko Mining and HMM Education Trust were acquired using vendor finance with the loans repayable via distributions attributable to these parties, pro rata to their share in HMM. Until these loans are repaid, South32's interest in HMM is accounted at 54.6%.

(c) H1 FY17 reflects balance as at 30 June 2017.

Cerro Matoso (99.9% SHARE)

Volumes

Cerro Matoso payable nickel production increased by 23% (or 4.1kt) to 21.8kt in H1 FY18 as ore grades improved with the ramp-up of production at the higher grade La Esmeralda deposit.

FY18 production guidance remains unchanged at 41.6kt with additional maintenance planned for the furnace in the March 2018 quarter.

Operating costs

Operating unit costs decreased by 10% to US$3.41/lb in H1 FY18 as the operation benefitted from a substantial increase in sales volumes.

We have updated FY18 unit cost guidance to US$3.61/lb to reflect revised exchange rate and price assumptions. Exchange rate and price assumptions for FY18 unit cost guidance are detailed on page 25, footnote 20.

Financial performance

Underlying EBIT increased by US$45M in H1 FY18 to US$41M as the rise in sales volumes (+US$40M) and a higher average realised nickel price (+US$16M) were partially offset by higher royalties (-US$5M) and an increase in exploration activity (-US$3M).

Capital expenditure

Sustaining capital expenditure increased to US$11M in H1 FY18 as La Esmeralda was brought online and the project's permanent access bridge was completed.

(a) Inclusive of by-products. Realised sales price is calculated as sales revenue divided by sales volume.

(b) Operating unit cost is Revenue less Underlying EBITDA divided by Payable nickel sales volume.

(a) H1 FY17 reflects balance as at 30 June 2017.

Cannington (100% SHARE)

Volumes

Cannington silver, lead and zinc payable production decreased by 41%, 33% and 52% respectively in H1 FY18 as lower ore grades and a reduction in mill throughput impacted performance.

The stress regime within the orebody is evolving with depletion and we are moving to more challenging areas within the mine plan. In order to deliver greater predictability and stability in the underground mine as the level of activity increases (80 stopes to be extracted in FY19, average of 50: FY12-16), we are lowering the mining rate to 2.45 Mt per annum which is expected to translate to mill throughput of 2.3Mt and 2.4Mt in FY18 and FY19, respectively.

Operating costs

Operating unit costs increased by 30% to US$170/t in H1 FY18 as a result of the reduction in throughput and an adverse movement in finished goods inventory.

We have updated FY18 unit cost guidance to US$159/t to reflect revised exchange rate and price assumptions. Exchange rate and price assumptions for FY18 unit cost guidance are in footnote 20.

Financial performance

Underlying EBIT decreased by 56% (or US$93M) in H1 FY18 to US$72M as lower sales volumes (-US$148M) were partially offset by higher average realised prices (+US$32M) and lower treatment and refining charges (+US$27M). The ramp-up of underground trucking activity successfully replaced shaft haulage in the period for a modest US$2M increase in costs. Finalisation adjustments and the provisional pricing of Cannington concentrates increased Underlying EBIT by US$5.5M in H1 FY18 (US$4.1M FY17; US$0.5M H1 FY17). Outstanding concentrate sales (containing 1.8Moz of silver, 21.1kt of lead and 3.9kt of zinc) were revalued at 31 December 2017. The final price of these sales will be determined in H2 FY18.

Capital expenditure

Sustaining capital expenditure increased to US$23M inH1 FY18. The underground crusher is now expected to be commissioned in February 2018, ahead of schedule.

(a) Realised sales price is calculated as sales revenue divided by sales volume.

(b) Operating unit cost is Revenue less Underlying EBITDA divided by ore processed. Periodic movements in finished product inventory may impact operating unit costs as related marketing costs and treatment and refining charges may change.

(a) H1 FY17 reflects balance as at 30 June 2017.

NOTES

(1) Revenue includes revenue from third party products.

(2) H1 FY18 basic earnings per share is calculated as Profit/(loss) after tax divided by the weighted average number of shares for H1 FY18 (5,191 million). H1 FY18 basic Underlying earnings per share is calculated as Underlying earnings divided by the weighted average number of shares for H1 FY18.H1 FY17 basic earnings per share is calculated as Profit/(loss) after tax divided by the weighted average number of shares for H1 FY17 (5,319 million). H1 FY17 basic Underlying earnings per share is calculated as Underlying earnings divided by the weighted average number of shares for H1 FY17.

(3) H1 FY18 ordinary dividend per share is calculated as H1 FY18 interim dividend announced (US$223M) divided by the number of shares on issue at 31 December 2017 (5,181 million).

(4) H1 FY18 special dividend per share is calculated as H1 FY18 special dividend announced (US$155M) divided by the number of shares on issue at 31 December 2017 (5,181 million).

(5) Underlying EBIT is profit before net finance costs, tax and any earnings adjustment items, including impairments. Underlying EBIT is reported inclusive of South32's share of net finance costs and tax of equity accounted investments. Underlying EBITDA is Underlying EBIT, before depreciation and amortisation. Underlying earnings is Profit/(loss) after tax and earnings adjustment items. Underlying earnings is the key measure that South32 uses to assess the performance of the South32 Group, make decisions on the allocation of resources and assess senior management's performance. In addition, the performance of each of the South32 operations and operational management are assessed based on Underlying EBIT. In order to calculate Underlying earnings, Underlying EBIT and Underlying EBITDA, the following items are adjusted as applicable each period, irrespective of materiality:

· Exchange rate gains/losses on restatement of monetary items;

· Impairment losses/reversals;

· Net gain/loss on disposal and consolidation of interests in businesses;

· Fair value gain/loss on non-trading derivative instruments;

· Major corporate restructures; and

· The income tax impact of the above items.

In addition, items that do not reflect the underlying operations of South32, and are individually significant to the financial statements, are excluded to determine Underlying earnings. Significant items are detailed in the Financial Information.

(6) Comprises Underlying EBITDA excluding third party product EBITDA, divided by revenue excluding third party product revenue.

(7) Comprises Underlying EBIT excluding third party product EBIT, divided by revenue excluding third party product revenue.

(8) Return on invested capital (ROIC) is a key measure that South32 uses to assess performance. ROIC is calculated as annualised Underlying EBIT less the discount on rehabilitation provisions included in net finance cost, tax effected by the Group's Underlying effective tax rate (ETR), divided by the sum of fixed assets (excluding any rehabilitation asset and impairments) and inventories. Manganese is included in the calculation on a proportional consolidation basis.

(9) To ensure that incident classification definitions are applied uniformly across our workforce, we have adopted the United States Government Occupational Safety and Health Assessment (OSHA) guidelines for the recording and reporting of occupational injuries and illnesses.

(10) Total Recordable Injury Frequency (TRIF): The sum of (fatalities + lost-time cases + restricted work cases + medical treatment cases) x 1,000,000÷ actual hours worked, for employees and contractors. Stated in units of per million hours worked.

(11) Sales price variance reflects the revenue impact of changes in commodity prices, based on the current period's sales volume. Price-linked costs variance reflects the change in royalties together with the change in input costs driven by changes in commodity prices or market traded consumables. Foreign exchange reflects the impact of exchange rate movements on local currency denominated costs and sales. Volume variance reflects the revenue impact of sales volume changes, based on the comparative period's sales prices. Controllable costs variance represents the impact from changes in the Group's controllable local currency cost base, including the variable cost impact of production volume changes on expenditure, and period-on-period movements in inventories. The controllable cost variance excludes earnings adjustments including significant items.

(12) Underlying net finance cost and Underlying tax expense are actual H1 FY18 results, not half-on-half variances. 

(13) South32's ownership share of operations are presented as follows: Worsley Alumina (86%), South Africa Aluminium (100%), Mozal Aluminium (47.1% share), Brazil Alumina (Alumina 36% share, Aluminium 40% share), South Africa Energy Coal (92% share), Illawarra Metallurgical Coal (100%), Australia Manganese (60% share), South Africa Manganese (60% share), Cerro Matoso (99.9% share), and Cannington (100%).

(14) Underlying effective tax rate (ETR) is Underlying income tax expense, excluding royalty related tax, divided by Underlying profit before tax; both the numerator and denominator exclude equity accounted investments.

(15) The Mozambique operations are subject to a royalty on revenues instead of income tax.

(16) Total capital expenditure comprises Capital expenditure, the purchase of intangibles and capitalised exploration expenditure. Capital expenditure comprises Sustaining capital expenditure and Major projects capital expenditure. Sustaining capital expenditure comprises Stay-in-business (SIB), Minor discretionary and Deferred stripping (including underground development) capital expenditure.

(17) South32's interest in South Africa Energy Coal is accounted at 100% until Broad-Based Black Economic Empowerment (B-BBEE) vendor loans are repaid.

(18) Operating unit cost is Revenue less Underlying EBITDA, excluding third party sales, divided by sales volumes. Operating cost is Revenue less Underlying EBITDA excluding third party sales. Additional manganese disclosures are included on pages 21 and 22.

(19) Prior FY18 Operating unit cost guidance included royalties (where appropriate) and the influence of exchange rate assumptions, and were predicated on various assumptions for FY18, including: an alumina price of US$299/t; an average blended coal price of US$119/t for Illawarra Metallurgical Coal; a manganese ore price of US$4.50/dmtu for 44% manganese product; a nickel price of US$4.27/lb; a thermal coal price of US$72/t (API4) for South Africa Energy Coal; a silver price of US$16.82/troy oz; a lead price of US$2,135/t; a zinc price of US$2,555/t; an AUD:USD exchange rate of 0.74; a USD:ZAR exchange rate of 14.17; a USD:COP exchange rate of 2,961; and a reference price for caustic soda; all of which reflected forward markets as at May 2017 or our internal expectations.

(20) New FY18 Operating unit cost guidance includes royalties (where appropriate) and the influence of exchange rates, and includes various assumptions for FY18, including: an alumina price of US$388/t; an average blended coal price of US$168/t for Illawarra Metallurgical Coal; a manganese ore price of US$6.30/dmtu for 44% manganese product; a nickel price of US$5.39/lb; a thermal coal price of US$90/t (API4) for South Africa Energy Coal; a silver price of US$16.96/troy oz; a lead price of US$2,475/t; a zinc price of US$3,246t; an AUD:USD exchange rate of 0.78; a USD:ZAR exchange rate of 12.98; a USD:COP exchange rate of 2,920; and a 17% increase in the reference price for caustic soda relative to prior guidance; all of which reflected forward markets as at January 2018 or our internal expectations.

(21) Third party products sold comprise US$148M for aluminium, US$48M for alumina, US$128M for coal, US$85M for freight services and US$54M for aluminium raw materials. Underlying EBIT on third party products comprise US$6M for aluminium, nil for alumina, nil for coal, (US$1)M for freight services and nil for aluminium raw materials.

(22) Presented on a 100% basis.

(23) Metal Bulletin 44% manganese lump ore index (CIF Tianjin, China).

(24) Metal Bulletin 37% manganese lump ore index (FOB Port Elizabeth, South Africa).

(25) Figures in Italics indicate that an adjustment has been made since the figures were previously reported.

The following abbreviations may be used throughout this report: US$ million (US$M); US$ billion (US$B); December half year (H1 FY18); grams per tonne (g/t); tonnes (t); thousand tonnes (kt); thousand tonnes per annum (ktpa); million tonnes (Mt); million tonnes per annum (Mtpa); thousand ounces (koz); million ounces (Moz); thousand wet metric tonnes (kwmt); million wet metric tonnes (Mwmt); million wet metric tonnes per annum (Mwmt pa); thousand dry metric tonnes (kdmt); dry metric tonne unit (dmtu); pound (lb); megawatt (MW); Australian Securities Exchange (ASX); London Stock Exchange (LSE); Johannesburg Stock Exchange (JSE); and American Depositary Receipts (ADR).

SOUTH32 FINANCIAL INFORMATION

CONSOLIDATED INCOME STATEMENT

for the half year ended 31 December 2017

The accompanying notes form part of the half year consolidated financial statements. 

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

for the half year ended 31 December 2017

The accompanying notes form part of the half year consolidated financial statements.

CONSOLIDATED BALANCE SHEETas at 31 December 2017

The accompanying notes form part of the half year consolidated financial statements.

CONSOLIDATED CASH FLOW STATEMENT

for the half year ended 31 December 2017

The accompanying notes form part of the half year consolidated financial statements.

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY

for the half year ended 31 December 2017

(1) Represents 37,168,657 shares permanently cancelled through the on-market share buy-back during the period.

The accompanying notes form part of the half year consolidated financial statements.

NOTES TO FINANCIAL STATEMENTS - BASIS OF PREPARATION

The consolidated financial statements of South32 Limited (referred to as the Company) and its subsidiaries and joint arrangements (collectively, the Group) for the half year ended 31 December 2017 were authorised for issue in accordance with a resolution of the Directors on 15 February 2018.

1. Reporting entity

South32 Limited is a for-profit company limited by shares incorporated in Australia with a primary listing on the Australian Securities Exchange (ASX), a standard listing on the London Stock Exchange and a secondary listing on the Johannesburg Stock Exchange. The nature of the operations and principal activities of the Group are described in note 3 Segment information.

2. Basis of preparation

The half year consolidated financial statements are a general purpose condensed financial report which:

· Have been prepared in accordance with AASB 134 Interim Financial Reporting, IAS 34 Interim Financial Reporting and the Corporations Act

· Have been prepared on a historical cost basis, except for derivative financial instruments and certain other financial assets and liabilities which are required to be measured at fair value

· Are presented in US dollars, which is the functional currency of the majority of the Group's operations, and all values are rounded to the nearest million dollars (US$M or US$ million) unless otherwise stated, in accordance with ASIC Corporations Instrument 2016/191

· Present reclassified comparative information where required for consistency with the current period's presentation

· Have been prepared on the basis of accounting policies and methods of computation consistent with those applied in the 30 June 2017 annual consolidated financial statements

In preparing these half year consolidated financial statements, management has made judgements, estimates and assumptions that affect the application of accounting policies and the reported amounts of assets and liabilities, income and expense. Actual results may differ from these estimates. The significant judgements made by management in applying the Group's accounting policies and the key sources of estimation uncertainty were the same as those that applied to the consolidated financial statements as at and for the year ended 30 June 2017.

For a full understanding of the financial performance and financial position of the Group it is recommended that the half year consolidated financial statements be read in conjunction with the annual consolidated financial statements for the year ended 30 June 2017. Consideration should also be given to any public announcements made by the Company in accordance with the continuous disclosure obligations of the ASX Listing Rules.

The following exchange rates relative to the US dollar have been applied in the half year consolidated financial statements.

(1) Displayed as US$ to A$ based on common convention.

NOTES TO FINANCIAL STATEMENTS - RESULTS FOR THE PERIOD

3. Segment information

(a) Description of segments

The operating segments (also referred to as operations), are organised and managed separately according to the nature of products produced.

The members of the Lead Team (the chief operating decision makers) and the Board of Directors monitor the segment results regularly for the purpose of making decisions about resource allocation and performance assessment. The segment information for the manganese operations are presented on a proportional consolidation basis, which is the measure used by the Group's management to assess their performance.

The principal activities of each operating segment as the Group is currently structured are summarised as follows:

All operations are operated or jointly operated by the Group except Brazil Alumina, which is operated by Alcoa.

(b) Segment results

The Group separately discloses sales of group production from sales of third party products because of the significant difference in profit margin earned on these sales.

It is the Group's policy that inter-segment transactions are made on a commercial basis.

Group and unallocated items/eliminations represent group centre functions and consolidation adjustments. Group financing (including finance expense and finance income) and income taxes are managed on a Group basis and are not allocated to operating segments.

NOTES TO FINANCIAL STATEMENTS - RESULTS FOR THE PERIOD

3. Segment information (continued)

(b) Segment results (continued)