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Macquarie tips 40% upside for the South32 (ASX:S32) share price

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The South32 Ltd (ASX: S32) share price is rangebound today, now trading flat at $5.03. This follows a spike from the open before the mining company’s shares reversed sharply to bottom at $4.98 before recovering again.

As commodity baskets have soared in 2022, South32’s share price has followed suit, currently up 25% this year and 86% in the last 12 months.

Analysts at Macquarie are bullish on the stock and reckon it’s a buy right now. Let’s take a look at why the investment bank is urging its clients to get on board South32’s gravy train.

Is South32 a buy?

According to Macquarie analysts, South32 could be a buy right now. In fact, the firm is bullish on the entire commodity sector, noting soaring prices should be a strong tailwind for Aussie miners like South32.

“Our EPS forecasts increase materially over the next two periods for the major miners,” its analysts said.

In a recent note, the broker raised its price target by 32% to $7 per share. It noted South is set to produce mammoth free cash flow yields on the back of record commodity prices.

From its FY21 results to its current market value, South32 is currently trading on a 4.7% free cash flow (FCF) yield at the time of writing.

However, it is forecast to generate more than $2.22 billion in free cash flow for FY22, according to Bloomberg consensus estimates. This means investors are privy to a juicy 12.7% FCF yield this year.

But why is this so important? FCF yield is actually a ratio that analysts use to assess a company’s ability to meet its obligations. But, perhaps more importantly to us as investors, it also measures its ability to return cash to shareholders by way of dividends or share buybacks.

Put simply, the higher the FCF yield, the higher the prospects for big, fat, juicy, dividends or share buybacks that grow over time.

For example, Rio Tinto Ltd (ASX: RIO) recently paid the largest dividend in Australian history at more than $10 per share. However, at FY21’s end, it was trading on an FCF yield of 15.23% – up from 9.7% three years earlier.

Hence, brokers like Macquarie and others, like the prospects of South32’s projected free cash flow being redistributed back to shareholders over the coming periods.

It’s not all so rosy

However, not all appear to be that bullish on South32. Analysts at Barclays Investment Bank recently urged their clients to sell South32 shares – albeit those listed on the London Stock Exchange as opposed to the Australian stock.

Speaking to investors holding South’s London-listed shares, Barclays was unhappy with South’s most recent dividend and said the company could have perhaps done more with its $942 million in free cash flow.

“H1 dividend of 8.7 cents/share is below our 15.6 cents/share estimate (-44% below) and also 9% below consensus for a 40% payout ratio (our estimates were 75%),” it said in an update.

“The $405 million dividend plus $60 million of shares bought back delivers total returns in respect of H1 21 of $465 million and compares to $942 million [of] FCF.”

Aside from that, 76% of analysts covering the stock have it rated as a buy right now, according to Bloomberg data. The consensus price target is $5.31 per share, suggesting an upside potential of 5% at the time of writing.

That’s crept up from 60% of coverage saying to buy South32, whilst the average price target has jumped from $2.64 in the past 12 months.

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