South32 Ltd (ASX: S32) saw its share price hit a 6-month high of $1.73 earlier today, and is still up 3.7% at $1.68.

Commodities prices recovering

Earlier this year, the diversified miner saw its share price sink to a low of just 87 cents, as commodities prices sank. South32’s commodities include aluminium, thermal (energy) and metallurgical coal, manganese, nickel, silver, lead and zinc, with mines around the world including in Australia, Southern Africa and Brazil.

But a recovery in a number of commodities, including alumina and zinc had helped the miner. Thermal coal, nickel, lead and silver prices have also staged a recovery since February.

Commodities producers around the globe are cutting back on production – either to help push prices back to more sustainable levels, or because they have no choice and can’t continue running loss-making operations.

Production and debt down

As South32’s CEO Graham Kerr says, the company is focussing on value, not volume. In its latest quarterly report, the company saw production across most of its commodities fall, compared to the December 2015 quarter – but says it still expects to meet 2016 financial year production guidance.

Stronger prices and a heavy focus on cutting costs have seen net debt drop to just US$18 million at the end of March 2016. South32 says it remains on track to cut US$300 million of controllable costs from its business.

Where’s the value?

At the end of December 2015, South32 had US$1.69 of net tangible assets per share on its balance sheet – likely improved now with net debt down to US$18 million, from US$116 million at the end of December 2015.

At the current exchange rate of US 77.9 cents, that’s the equivalent of A$2.19, well above the current share price and suggests the share price could rise further.

I know BHP Billiton Limited (ASX: BHP) is a different kettle of fish, but at the end of December 2015, the giant miner had A$13.80 of net tangible assets per share – and its share price is currently $21.06. Another example is Independence Group NL (ASX: IGO) which had $3.72 worth of net tangible assets per share at the end of December 2015, and is currently priced at $3.42. Independence produces gold, nickel and zinc.

Foolish takeaway

If commodities prices continue to rise – they will drag South32’s share price with it. The simple reason is that price generally follows earnings and higher commodities prices should mean higher earnings.

Call me a bear if you want, but I have little confidence that commodities are going to see a sustained rally and fear that we could see lower commodities prices for much longer than expected. As such, I won’t be parting with my cash for shares in South32.

 

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Motley Fool writer/analyst Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.