South32 shares in red territory

BHP Billiton spinoff company South32 closed at R17.24 on Friday, dropping by 2.49%, down 10.3% on the week, and about 14.82% since it listed on the JSE over a month ago.

Currently sitting a R17.20 per share, Troy Brady from NOAH Capital Markets says South32 has simply become a victim of the general negative sentiment towards resource stocks in recent times.

Citing ArcelorMittal and African Rainbow Minerals as examples, both of which were down on Friday, Brady says it’s been a bad couple of months for everybody in the mining space, with the two stocks having lost 24% and 16% respectively in the last month.

“It’s important to keep in mind that the resources sector as a whole is in trouble because of the slowdown in China,” says Brady. “It also doesn’t help that some South32 commodities – manganese, coal, aluminium – have all recently been on a downward trend.”

He says South32 also faces challenges particularly on the aluminium side, because of its heavy reliance on Eskom, as it is a very energy-intensive operation.

“They’ve got an aluminium smelter in Richards Bay… I believe they do have some form of an agreement with Eskom (to keep the lights running or structure blackouts more efficiently), but when the time comes to renew that contract, I think it won’t be so favourable,” says Brady.

Kobus Nell from Stanlib says South32 is more sensitive to commodity price movements than other companies because it has higher operational leverage than the likes of BHP Billiton.

Says Nell: “South32 has lower margin type assets. Not the top quartile, tier 1 type of assets that you would find in, say, a BHP Billiton. They’re still good…. But with that comes higher operational leverage and commodity price sensitivity. Even BHP was down [on Friday], but not by much because they are less exposed to that kind of risk.”

It’s a view that seems to put to rest claims that South32 could be a better bet than parent BHP Billiton. But it doesn’t. What it means is that in periods of a downward cycle, BHP is better equipped to weather the storm, which is probably why the company chose to unbundle those assets in the first place.

However, Nell points out that South32 will is be significantly more responsive to a positive sentiment on resources and increases in commodity prices. So, if the company can get through these difficult times, only blue skies and green pastures lie ahead.