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As BHP Billiton plc Plunges To A New 5-Year Low, Should You Sell And Buy South32 Ltd?

BHP Billiton’s (LSE: BLT) recent spin-off, South32 (LSE: S32) has fallen out of favour with the market during the past month. The company’s shares have slumped by around 20% since the middle of May. Over the same period, BHP’s shares have lost around 17%.

However, South32’s shares have been artificially depressed by forced selling, the majority of which should now be complete.

In particular, BHP has been gradually selling down a 1% stake in South32 since the new company began trading on May 18. While it’s also believed that many private, as well as institutional investors sold their gifted South32 shares soon after the spin-off took place.

But now that the majority of the selling has been completed, South32’s shares are starting to look attractive.

Diversified assets

BHP is built around a four pillars strategy: the company relies on four main commodities — coal, iron ore, oil and copper — to generate the majority of its income.

The spin-off of South32 was part of this strategy. Divesting unwanted assets into South32 was supposed to help BHP refocus its efforts on the four key commodity pillars. 

However, BHP’s strategy to streamline its portfolio hasn’t gone exactly to plan.

After spinning off South32, the prices of coal, oil, copper and iron ore have all slumped. Now, BHP is overly exposed to four commodities with increasingly poor fundamentals. 

South32, on the other hand, owns a wider range of assets. The group has 12 assets or joint ventures in five countries producing seven commodities — bauxite, alumina, aluminium, thermal and metallurgical coal, manganese, nickel, silver, lead and zinc.

Moreover, the smaller entity has a crucial size and flexibility advantage over its parent. For example, earlier this year the group was praised by analysts for announcing that it would indefinitely delay the restart of three of the four furnaces at its Metalloys smelter near Johannesburg, in response to falling commodity prices. 

Depressed valuation

South32’s diversification and flexibility are two key reasons why the company could be a better bet than BHP. A third reason is the company’s low valuation.

Indeed, at present levels South32 is trading at a forward P/E of 9.8 and the group is trading at a price to tangible book value of 0.4. At this valuation, any buyer could swoop on South32 at present levels and buy the company’s assets for 40% of replacement cost — an offer that could be too hard to pass up.

On the other hand, BHP is currently trading at a forward P/E of 13.7 and a P/TB of 1.4. Still, the company does support a dividend yield of 6.6%.

South32 has stated that it plans to payout around 40% of earnings as an annual dividend. Based on earnings forecasts, shareholders could be in line for a yearly payout of 4p per share, a yield of 4.7% based on current prices.

A vote of confidence

Along with the three key advantages noted above, South32 has also received a vote of confidence from two of the largest names in the mining industry.

It is rumoured that Mick Davis, Xstrata’s former boss and now manager of cash shell X2 Resources, as well as Glencore, managed by Ivan Glasenberg, have both been considering an offer for South32.

Mick Davis and Ivan Glasenberg are deemed to be two of the world’s most successful commodity investors, and they will only consider buying assets of the highest quality — a great vote of confidence for South32. 

 

The bottom line

All in all, after recent declines that have been driven by forced selling, South32's shares now look attractive.

Nevertheless, if you're an income seeker, BHP remains the better bet.

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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.