South32 gets popular

South32's quarterly report confirms that our investment case is on track. Others are starting to agree.

South32 has released quarterly production figures that confirm our investment case is on track. Costs are being ripped out of the business at an astonishing rate with management confirming that over US$300m would be saved this year alone.

The company is now debt free and carried a cash position of US$18m, perhaps the only debt free major miner in the world.

The market is finally starting to agree with our view. Since the start of the year, South32’s share price has rocketed more than 60%, predictably triggering a swathe of broker upgrades and buy calls. Six months ago your analyst couldn’t find another buyer of the stock; now they are everywhere.

Despite the enthusiasm, we are more cautious now than then. There are two main threats; Chinese overcapacity and persistently lower commodity prices.

The business depends on aluminium for about a third of profits and, with the global aluminium market grossly oversupplied China, the largest producer, shows no signs of cutting output. China’s commitment to steel production doesn’t appear as strong however. International pressure to curb rising Chinese steel exports has hit fever pitch and the government has promised action.

Lower Chinese steel output would hurt the price of steel-making ingredients – manganese, coking coal, and nickel. For South32, these represent about 40% of profits so it's a major risk.

While South32's share price has rebounded strongly and remains our favourite miner, we are cutting the buy prices in our recommendation guide. Although no longer the screaming bargain it was last year, South32 remains underpriced. Below $1.90 a share, it remains a BUY

Note: The Intelligent Investor Growth and Equity Income portfolios own shares in South32. You can find out about investing directly in Intelligent Investor and InvestSMART portfolios by clicking here.

Disclosure: The author owns shares in South32.

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