See why this broker just upgraded South32 shares to a buy

Commodity prices continue to create tailwinds for ASX stocks.

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South32 Ltd (ASX: S32) shares have been popular with investors throughout 2024 and have advanced more than 10% this year.

Volatility in commodity prices and a surge in metals demand from the electrification 'megatrend' are two tailwinds behind companies like South32 in the basic materials sector.

South32 shares are trading at $3.65 each at the time of writing after a broker upgraded the miner to a buy due to recent strength in commodity prices. Here's a look.

Why UBS upgraded South32 shares

UBS has raised its earnings projections for South32 by 13% to 34% for the 2024 to 2026 financial years. This is due to higher prices for manganese and alumina – two critical metals used in the production of ceramics, gasoline, steel and aluminium.

UBS mining analyst Lachlan Shaw said the firm was bullish on South32 as prices of these metals begin to stretch higher.

"Prices across South32's commodity basket are now a strong tailwind to earnings and free cash flow optionality," Shaw told the Australian Financial Review.

At the time of writing, the price of Manganese ore has shot to 42.50 CNY/mtu from a low of 29.144 CNY/mtu on 1 January.

Meanwhile, according to the London Metals Exchange, alumina prices were USD $498 per metric tonne on 13 June, up from USD $332/mt in December 2023.

The broker has increased its price target for South32 shares to $4.15 from $3.90, which represents a 14% upside potential at the time of writing.

Other broker insights on South32

Macquarie has also shown optimism about South32 shares, especially due to its copper exposure. According to my colleague James, in late May, Macquarie reaffirmed its outperform rating on South32 shares with an upgraded price target of $4.25. This suggests a potential upside of nearly 16% based on the current share price.

Furthermore, in a May note, Goldman Sachs maintained a buy rating on South32 shares. Despite minor adjustments to its FY 2024–2026 earnings before interest, tax, depreciation, and amortisation (EBITDA) estimates, Goldman Sachs raised its 12-month price target for South32 to $4.00.

It highlighted the company's improving free cash flow (FCF) and attractive valuation. "We forecast ~US$550mn of FCF in the June half," its analysts noted. Goldman also emphasised the positive outlook for key commodities like copper, aluminium, zinc, and metallurgical coal.

South32's strong financial outlook is a key reason for these positive broker ratings, in my opinion. Higher commodity prices have significantly boosted the company's earnings and free cash flow projections, which could help fund dividends and share repurchases.

UBS's Lachlan Shaw also mentioned that a restart of the company's buyback program at the FY 2024 results "cannot be ruled out", according to the AFR.

Why South32 shares might be worth watching

The recent upgrades from UBS, Macquarie, and Goldman Sachs show a strong positive sentiment towards South32 shares.

With improved commodity prices and robust financial performance, the company might be positioned well for growth. Just remember to consider your own personal financial circumstances and to conduct your own due diligence.

Motley Fool contributor Zach Bristow has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. 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 Scott Phillips.

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