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South32, Fortescue shares rise on mining’s new, unlikely reputation as safe

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Fund managers have driven the share prices of miners such as South32 and Fortescue Metals Group to 12-month highs because while many sectors are offering uncertain returns, mining stocks are gaining a reputation as “the lesser of evils”, they say.

South32 was the best-performing stock among the S&P/ASX200 on Tuesday after climbing 5.4 per cent or 10¢ to $1.95 a share.

The stock is slowly creeping back towards its May 2015 market debut of $2.13 per share, up about 120 per cent from a January low and 20 per cent in the past month alone, buoyed by investors’ more favourable approach to mining stocks.

In a research note on the company on Tuesday, Credit Suisse analysts said South32 was progressively being viewed as a safe option by investors in a mining sector that offered “the lesser of evils among uncertain equity classes”, such as financials and healthcare.

“There seems to be now a growing consensus that in the nearer term commodities may be a decent place to park money given the US [Federal Reserve] that has deferred its tightening and with China likely to do enough economic stimulus to underpin growth at reasonable levels,” Credit Suisse said.

“While we don’t see investors becoming commodity bulls, we do see investors moving money back into commodity exposures with the full knowledge that once China stimulus stops, commodities will be back under pressure again.

Safer plays

“Given South32’s balance sheet strength, it is perceived by many investors as one of the relative safer commodity plays.”

On Tuesday, Fortescue shot through the $4 per share mark for the first time since mid-2014, closing up 2.5 per cent at $4.17 per share. BHP Billiton also closed 1.68 per cent higher at $19.93 per share.

Shaw and Partners analyst Peter O’Connor said the rapid share price increases in Fortescue, South32 and other mining stocks such as Whitehaven Coal were “more of a fund flow story than an investment fundamentals story”.

“This is really being driven by fund buying, because the stocks are getting large enough they are starting to make a difference to their portfolio by either being there or not being there, as well as index buying,” Mr O’Connor said.

“On top of that, the level of short interest in stocks like Fortescue is close to a five-year low and resources stocks are incredibly under-owned locally. So put those two facts together, you can’t buy them as easily because they aren’t being shorted and you have an audience starting to get interested, and against that backdrop nearly every stock I cover has been blown through my target price in the past few weeks.”

Mr O’Connor said he expected the price drive to ease by September and, looking forward, the catalysts for South32 and Fortescue would depend on how they handled their balance sheets.

Act cautiously

“It becomes a de-leveraging story for Fortescue which probably has another $1 to $1.50 [per share] to go if it just de-leveraged over the next three years and did nothing else,” he said.

Fortescue repaid $US2.9 billion of debt last financial year as part of a target to push its debt-to-equity ratio below 40 per cent.

In South32’s case, it is more about what it does with its cash.

“It has a good balance sheet and it is likely to pursue some form of growth, but if anything it will act cautiously,” Mr O’Connor said.

Patersons Securities head of research Rob Brierley agreed, noting “that there is a lot more upside to be derived from its current asset base and we think this is under-appreciated by the investment community.”

Credit Suisse said South32 might have “missed the boat” for mergers and acquisitions because potential targets Whitehaven and Independence Group had both “moved up sharply and the merger math is now less compelling”, making capital returns “inevitable”.

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