South32 Ltd is worth more than I expected

Disclosure: I own shares in BHP Billiton and South32.

Back in January, ahead of the spin-off of South32 Ltd (LON:S32) from BHP Billiton plc (LON:BLT), I wrote “How much is BHP Billiton spin-off South32 worth to shareholders?“.

That article is currently the most popular post on this site, so I thought I’d look back at my three valuations and compare them to how the market has valued South32 shares, which started trading towards the end of May.

Price-to-sales ratio

My prediction: I suggested that based on its peer group, South32 might trade with a price-to-sales ratio of 1. This would equate to a share price of 115p.

The reality: As I write, South32 shares trade on a P/S ratio of 0.85 and a share price of 105p. If the P/S ratio rose to 1, the share price would be 123p.

Conclusion: I was pretty close.

Book value

My prediction: Based on the figures provided by BHP before the spin-off, my calculations suggested that South32 could have a book value of $11.3bn, which would equate to 140p per share.

The reality: The pro-forma balance sheet in the South32 UK prospectus suggests a net asset value of $12.95bn. This equates to 158p per share, so I wasn’t far off. However, the shares currently trade at a slightly larger discount to book value than I expected, on a price-to-book ratio of 0.7.

Note: users of Stockopedia and other data services might see the firm’s book value stated as $16.7bn, giving a per share figure of $3.14 or about 204p. This figure is listed in the same prospectus document as “Invested capital attributable to members of South32” based on the new firm’s historical accounts. It appears to be stated before the adjustments made in the demerger. I’ve chosen the more conservative pro-forma figure, but I’m not entirely sure which is more accurate. DYOR as usual. We’ll get a more accurate idea when South32 publishes its first set of accounts as an independent company. Year-end is June 30, so probably in Aug/Sep.

Conclusion: Based on the pro-forma figures, my estimate of book value per share wasn’t far off, but the market is being a little more cautious than I expected.

Price-to-earnings ratio

My prediction: I suggested that South32 could start trading with pro-forma earnings per share of around 9 cents, or roughly 6p.

The reality: I was partly right. The trailing twelve month (TTM) figures give earnings of 9.4 cents per share, in-line with my calculations. I suggested the shares could trade on a P/E of 10, giving a share price of just 60p per share.

This was my worst-case scenario and has been proved partly right: South32 is trading on a P/E of 11, but it’s a forecast P/E, based on this year’s forecast earnings of about 9p per share.

Conclusion: Analysts have crunched the numbers and expect South32’s full-year earnings to be better than I expected.

As my estimate came from simply extrapolating the BHP EBIT figures, the analysts’ techniques and information should be better than mine. In this case I’m happy to have been proved wrong too cautious.

Buy or sell South32?

In my original article, I suggested that South32 shares could be received very cautiously by the market. As it’s happened, I think they’ve had a fairly positive reception, helped by a strong earnings outlook than I estimated.

At 105p, selling South32 would give a 7% yield on BHP shares purchased at 1,500p, or 5.25% on shares purchased at 2,000p. If you’re not interested in holding a small portion of South32, then selling will effectively give you a tidy special dividend.

I’m going to hold for a little longer, however, as I think some modest upside might be possible.

Disclaimer: This article is provided for information only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.