South32 (ASX:S32) share price on watch after being added to conviction buy list

The South32 Ltd (ASX:S32) share price could be heading higher today after being added to a leading broker’s conviction buy list…

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The South32 Ltd (ASX: S32) share price will be one to watch closely on Wednesday.

This follows news that the mining giant has been added to a leading broker’s conviction buy list.

What happened?

Goldman Sachs has been looking into the mining sector and has made changes to many of its recommendations.

One of those was adding the South32 share price to its conviction buy list with an improved price target of $3.40.

This price target implies potential upside of 18.5% over the next 12 months excluding dividends. Including the 5% dividend yield Goldman is expecting over the next 12 months, this return stretches to over 23%.

What did Goldman say?

The broker made the move after increasing its earnings per share estimates for FY 2021 and FY 22 by 12% and 31%, respectively. This was to reflect revisions to foreign exchange and commodity price estimates.

Based on these earnings estimates, Goldman feels the South32 share price is trading at an attractive level. This is particularly the case given its recovering free cash flow.

It commented: “We forecast a FCF yield of c.12% over the next two years, driven by our forecast 2% lift in Cu Eq production in FY21, S32’s decision to defer US$100mn in sustaining capex in FY21 and lowering cost base, and the recent removal of the Dendrobium Next Domain (DND) extension met coal project from our Illawarra mine model.”

Another reason the broker is positive on South32 is its commodity mix.

Goldman explained: “In addition to base metals (aluminium, nickel), we are also positive on alumina, met coal and manganese prices in 2H 2021 and 2022. These commodities represent over 50% of S32’s EBITDA.”

Finally, Goldman notes that the company’s restructuring has a number of benefits.

“S32 expects the sale of SA Energy coal to close imminently; pending closure we do not include this proposed transaction in our estimates; however, we estimate a potential net c. A10cps benefit (c.3% lift in our NAV) with the removal of US$875mn in asset closure provisions on the deal’s closure. This number also accounts for the recently revised deal structure in which S32 will provide an additional US$200mn in rehabilitation aid and a US$50mn working capital facility to Seriti, the acquirer of SAEC; this should provide Eskom and SA Treasury the confidence in the final sign-off on the transaction.”

All in all, Goldman believes the South32 share price is ain the buy zone today.

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Motley Fool contributor James Mickleboro has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. 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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