Miners have been on a tear since mid-January when the sector was trading close to a two-decade low.
However, as investor sentiment has improved over the past eight weeks miners have staged a recovery, and South32 (LSE: S32) is leading the charge. Indeed, over the past eight weeks shares in South32 have risen 94%, and shares in the company’s former parent, BHP Billiton (LSE: BLT) are close behind having racked up gains of 33%.
These gains have been enough to convince some investors that the mining sector is starting to recover. But while miners have been rallying since mid-January, the underlying market fundamentals haven’t improved significantly. Key commodity markets are still oversupplied, and questions remain about China’s economic growth. What’s more, global trade growth has slowed to recessionary levels and emerging market growth is faltering.
With this being the case, it’s difficult to buy into the recent mining sector rally. Mining stocks have rallied hard and fast, although it seems as if this is more to do with short covering than anything else. So, South32’s rally could be nothing but hot air.
On the other hand, BHP remains the world’s largest diversified miner, and while recent gains in the company’s share price may be overdone, BHP still has all the traits of an attractive long-term investment.
BHP over South32?
Why BHP over South32? Well, for a start BHP has some of the lowest production costs in the mining industry, which gives it flexibility throughout all stages of the mining cycle. Moreover, the company’s size and asset base, coupled with a relatively clean balance sheet means that banks and other creditors are happy to lend to the miner, allowing it to remain solvent during times of stress.
Also, BHP’s production profile is more diversified than that of its smaller peer. Three key commodities, coking coal, aluminium and manganese, make up around 75% of South32’s earnings before interest and tax. BHP produces four primary commodities, coal, copper, iron ore and oil.
The better long-term choice
So, even though South32’s shares have doubled during the past eight weeks, BHP’s size and diversification mean that it’s the better choice over South32 for long-term investors. And BHP is currently trading at a more attractive valuation than its smaller peer.
BHP is currently trading at a forward P/E of 80.2, falling to 36.5 next year. South32 is currently trading at a forward P/E of 22,106, falling to 4,104 next year. On the yield front, BHP once again looks more attractive than its smaller peer. BHP’s shares currently support a dividend yield of 3.8%; even after the recent payout cut. South32’s shares are only set to support a dividend yield of 0.3% for this year.
All in all, investors shouldn’t be misled by the recent performance of South32’s shares. Underlying market fundamentals are still signalling further pain ahead for the miners and BHP is one of the few miners with the firepower in place to survive a protracted downturn.
