Citigroup upgrades South32 Ltd (ASX:S32) amid the mining carnage

Mining stocks may be bouncing back today but the big sell-off in the sector is never far from the minds of investors, no thanks to the escalating global trade war.

But investors might look to buy diversified base metal miner South32 Ltd (ASX: S32) amid the chaos after Citigroup upgraded the stock to “buy” from “neutral” and lifted its price target by over 13% to $4.30 a share.

This means there’s a close to 30% upside to the stock if you included its expected dividend, even after you account for South32’s 1.7% share price rally during lunchtime trade to $3.55.

“We have made upgrades to FY19/20 EPS forecasts driven by commodity prices, weaker AUD and EPS accretion from [share] buybacks,” said Citigroup.

“S32 has a very strong balance sheet which we expect to remain in net cash position even after accounting for US$1.4b outflow for acquisition of 50% interest in Eagle Downs and remaining 83% interest in Arizona Mining.”

But the verdict on South32 isn’t unanimous with some experts unimpressed by the miner’s mixed production report and escalating costs.

The impact of the US President Donald Trump’s trade spat with China and the ensuing currency war could put a big dent in commodity prices and the prospects of our miners including BHP Billiton Limited (ASX: BHP), Rio Tinto Limited (ASX: RIO) and Western Areas Ltd (ASX: WSA).

However, there is consensus on the upside for South32 if spot prices were to hold around current levels with most analysts agreeing that the stock will need to run another 30% to reach fair value if the price forecast of manganese, coal and other minerals were to be upgraded to spot prices.

UBS ran this scenario through its models and found that South32, Alumina Limited (ASX: AWC) and Whitehaven Coal Ltd (ASX: WHC) had the most to gain.

On the other hand, earnings for BHP and Rio Tinto will fall by 4% if the spot prices were used on the commodities they are most exposed to, added UBS.

Despite the uncertainty over commodity prices, which is driven in part by the fluctuating US dollar, the mining sector remains one of the best places to be invested in ahead of the August reporting season.

Our biggest miners are able to generate strong profits even if commodity prices soften due to low operating costs, while their cashed-up balance sheet gives them the flexibility to make opportunistic acquisitions and/or return cash to shareholders.

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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 Scott Phillips.

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