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The Experts

Not full of ‘crap’

Michael McCarthy
Friday, September 14, 2018

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When BHP spun its unwanted operations off in 2015, a number of market wits labelled it “Crapco”. BHP investors, who received South 32 shares for free, bailed out. After an initial six month sell down, South 32’s shares quadrupled from their lows.

South 32 is politely described as a diversified metals and mining company. It produces alumina, aluminium, coal, manganese, nickel, silver, lead and zinc. Apart from coal and aluminium, most of these products are nearer cycle lows. Despite this conservative positioning and a relatively low leverage, South 32 is trading at an unstrained forward Price to Earnings ratio around 10 times.

On August 23, South 32 reported an 8% increase in profit for the full year. Management issued slightly increased guidance costs, as part of an outlook statement some analysts view as cautious. Reactions were mixed, with the stock subject to both upgrades and downgrades. The stock had traded down into the announcement and has bounced since, albeit with higher volatility.

The Materials sector is one of the “cheapest” on the market by traditional measures, such as P/E to Growth, and Enterprise value to Earnings. Surprisingly, it also has one of the higher sectoral expected returns. South 32 is shunned by some because it is expected to see lower earnings from 2021 onwards. However in the short term, it has stonking free cash flows that are likely to find their way into shareholders one way or another.

Further there is evidence this week that the trade dispute is turning in favour of China. Reports that the US is now seeking trade discussions and that China is has battened down the hatches in preparation for a prolonged disagreement may see the performance gap between the S&P500 and the Shanghai composite closing. This potential evidence of a stronger China is supportive of metals and coal prices. The twitter silence on trade from the Oval Office is ominous for the US.

South 32 could be just the ticket as the tide turns, especially for investors who are underweight growth exposure but blanch at the prospect of paying eye-watering multiples for tech darlings.

Published: Friday, September 14, 2018

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