Should you be excited about South32 Ltd’s $1.7bn cash giveaway?

The market isn’t quite taken by South32 Ltd’s (ASX: S32) cash splash of special dividends and expanded share buybacks with the stock tumbling into the red despite a strong rally in the resources sector.

The diversified base metals miner announced that it will return US$378 million to shareholders in dividends and expand its capital management program by US$250 million to US$1 billion on the back of a 14% increase in underlying net profit to $544 million for the six months to end-December 2017.

The dividend includes a US4.3 cent ordinary interim dividend and a US3 cent a share special dividend.

Our love for dividends shouldn’t be underestimated but the news failed to excite the market as the stock sank 2.7% to $3.60 in afternoon trade.

There are a couple of likely reasons for this. Investors weren’t too happy about rising costs which caused its operating margin to contract by 1 percentage point to 35.7% in the period.

Half of South32’s 10 mining projects felt a margin squeeze in 1HFY18 compared to the previous quarter and there’s no relief in sight thanks to higher input costs impacting on its smelters and the rising Australian dollar affecting its cost base.

The miner lifted its cost guidance on just about all its operations with Worsley Alumina and its lead-silver-zinc Cannington mine.

Cannington’s ore body is depleting which means higher costs to extract the ore and lower production throughput. This is why management has cut its production guidance by 12% and 19% for FY18 and FY19, while keeping its FY18 guidance on its other assets with next to no increases for the following year.

Thank goodness for the surprisingly resilient commodity prices, which is helping offset the disappointment from rising costs and no production upside surprises.

Couple this with South32’s stellar rally over the past year and you can understand why investors are not jumping in to buy the stock at the moment.

Shares in South32 have rallied 34% over the past 12 months when the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) has only managed to inch up less than 2%.

Even the outperforming mining giants can’t keep up. BHP Billiton Limited (ASX: BHP), which South32 spun out from, is up 18% while Rio Tinto Limited (ASX: RIO) is up 21%.

However, I doubt South32 will fall much from here due to the strong outlook for base metals, particularly in a rising inflationary environment.

The miner also has a pretty strong balance sheet and good operating assets. It is difficult to find a better alternative stock in our market if you are looking for a wide exposure to base metals.

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Motley Fool contributor Brendon Lau owns shares of BHP Billiton Limited, Rio Tinto Ltd., and South32 Ltd. 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.

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