Why South32 Ltd (ASX:S32) is one of my key picks in the mining sector

The market couldn’t quite decide what to make of South32 Ltd’s (ASX: S32) quarterly report today with the stock slumping in the morning before staging an afternoon recovery.

Shares in the diversified miner crashed nearly 2% at the open but steadily crept higher to trade up 0.5% at $3.84 at the time of writing when the materials sector is in the red as the S&P/ASX 200 (Index:^AXJO) (ASX: XJO) index slipped 0.1%.

While South32’s quarterly report card showed a mixed bag of results, I thought it was pretty good – certainly better than the one handed in by BHP Billiton Limited (ASX: BHP) yesterday.

Production of a number of South32’s commodities fell including alumina (down 11% quarter-on-quarter to 1.2 million tonnes) and energy coal (down 10% to 6.6 million tonnes).

But manganese and metallurgical coal were standouts with production of the former rising 8% quarter-on-quarter (QoQ) to 1.5 million wet metric tonnes while coal used for steel production surged 39% to 1.5 million tonnes.

The big improvement in metallurgical coal was driven by a sharp improvement at South32’s Illawarra mine where production increased by 54%. This is likely ahead of what most analysts were expecting.

Manganese production was a record and comes at a time when demand and price of the commodity are high.

What’s more, management is expecting production to increase for just about all its commodities, including alumina and energy coal.

South32 is my key pick in the sector outside of BHP and Rio Tinto Limited (ASX: RIO) because it’s the most leveraged to spot prices.

It’s more leveraged than its peers like Independence Group NL (ASX: IGO) and OZ Minerals Limited (ASX: OZL).

If prices for its key commodities hold around current levels over the medium term, the stock will enjoy very substantial consensus earnings upgrades.

But predicting commodity prices is a risky call even in normal time – let alone in this climate where trade tensions between the US and China are at an all-time high.

South32’s leverage to spot prices is a double-edged sword because if commodity prices suffer a sharp correction as China’s economic growth hits a big stumbling block, its share price could easily halve – not that I am expecting such an Armageddon scenario.

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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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