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Why I think shares in South32 Ltd (ASX:S32) could go to $4

Today might belong to IT stocks yet again but you shouldn’t overlook “old economy” stocks like diversified miner South32 Ltd (ASX: S32) as its share price rallied to a more than one-week high.

Shares in the miner jumped 5.1% to $3.42 in late afternoon trade when the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index is down 0.2%.

The gain may not look as impressive as today’s run in WiseTech Global Ltd (ASX: WTC), Webjet Limited (ASX: WEB) or Appen Ltd (ASX: APX) with the stocks up between 15% and 24%, but it’s still a great performance after South32 posted results that came in ahead of expectations.

The miner posted a 9% jump in revenue to US$7.55 billion and a 16% uplift in underlying earnings to US$1.33 billion.

The improved margin came somewhat as a surprise to me as rising cost pressures has been a key theme during this reporting season.

The analysts at Macquarie Group Ltd (ASX: MQG) described the results as “solid” and noted that underlying earnings were 7% ahead of its estimates.

“We note that seven of S32’s ten operating assets reported stronger EBITDA. SA Manganese, Illawarra, Mozal and SA Energy Coal all reported +US$20m beats at the EBITDA [earnings before interest, tax, depreciation and amortisation] level,” said the broker.

“Cash generation was better than we had expected, allowing net cash at the end of June to rise to US$2.0bn, 17% ahead of our estimate.”

Management is guiding for a 5% increase in group production in FY19 and said that productivity gains, the high US dollar and lower caustic soda prices should provide some offset to ongoing inflationary pressure.

But it wasn’t all good news. Some like Macquarie had expected the miner to announce additional capital returns like a special dividend on the back of the better-than-expected result. South32 still has US$360 million left in its capital management program that will be handed back in FY19.

“The final dividend of US6.2¢ was lower than expected as we had assumed an additional US3.2¢ special dividend would be declared,” added Macquarie.

“The lack of additional capital management is slightly disappointing but reflects S32’s increased commitment to growth, with US$1.5bn in acquisitions already announced and completed in the 1HFY19.”

Depending on the exchange rate at the time of the final dividend conversion, the stock should be sitting on a yield of around 5.8% when franking is included for FY18 and I am expecting the dividend to increase this financial year.

Macquarie has an “outperform” recommendation on the stock with a price target of $4 a share.

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Motley Fool contributor Brendon Lau owns shares of Macquarie Group Limited and South32 Ltd. The Motley Fool Australia owns shares of Appen Ltd and WiseTech Global. The Motley Fool Australia has recommended Webjet Ltd. 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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