Upgrading sector earnings 15% in CY/FY18, FCF yield at +10%.
Downgrading sector earnings 3-4% but FCF yield remains at +10%
We are upgrading our price forecasts for met. coal, copper, nickel, zinc, andmineral sands. Supply-side cuts remain the key driver into next year, and weexpect prices for the bulks to fall from current levels. We are more positive onthe base metals and see deficits persisting and supporting prices. We haveupgraded mining sector earnings by 15% in CY/FY18, but note that equitiesgenerally appear fully valued (1.1xNPV, ex-RIO and BHP). The sector is tradingon +10% FCF yield, with gearing dropping to just 12% in 2018. Our top picksare RIO, BHP, SFR, & SBM. Our SELL ratings are ILU, NCM, NST, RRL & WSA.
We are downgrading our price forecasts for nickel, zinc, copper, oil and ironore but upgrade aluminium and alumina. Demand for commodities remainsconstructive but swing supply has returned in the bulks and prices should fall abit further. We remain more positive on the base metals (zinc, copper,aluminium). We have downgraded mining sector earnings by 3-4% butvaluations remain undemanding given the recent sell off, with the sectortrading on 0.9xNPV, 11% FCF yield and gearing dropping to just 11% in 2018.Our top picks are RIO, EVN, SFR, SYR and MIN. Our SELL ratings are ILU, RRL,NCM. We upgrade AWC to HOLD and downgrade NST to SELL.Upgrading; aluminium, alumina, zircon, downgrading; nickel, zinc, copper, oilMajor upgrades to our commodity forecasts in this review are; aluminium(+5% to US85c/lb in 2017, +8% to US84c in 2018vs. spot US85c) and alumina(+8% to US$317/t in 2017, +7% to US$300in 2018, and long run +3% toUS$300/t vs. spot US$306/t) due to strong demand and impacts from China’sproposed heating season cuts, zircon (ILU’s average realised price +7% toUS$886/t in 2017, +12% to US$1,025in 2018). Major downgrades include;
We upgrade OZL to HOLD, downgrade OGC, IGO to HOLD, WSA to SELL.
nickel (-7% to US446c/lb in 2017, -9% US465vs. spot US410c), zinc (-14% toUS121c/lb in 2017, -2% US113vs. spot US115c), copper (-3% to US258c/lb in2017, -3% US300c in 2019vs. spot US259c), and oil (down 10-15% from 2017-2021and now forecasting US$53-56/bbl Brent from 2017-2019). We have alsotrimmed our 2017iron ore price forecast by 7% to US$64/t and expect theprice to average US$55/t in 3Q and US$50/t in 4Q on stronger seaborne supplyfrom the majors. However, we expect high cost supply to exit below US$60/t.
Upgrading; coking coal, copper, nickel, zinc, mineral sands.
Top Picks; RIO, EVN, SFR, SYR, MIN, SELLs; ILU, RRL, NCM, RRL, NST
Major upgrades to our commodity forecasts in this review are; coking coal(+48% to US$170/t in 2018, +17% to US$140/t in 2019 vs. spot US$183/t),base metals; copper (+15%/+5%), nickel (+12%/+13%), zinc (+12%/+19%) in2018/19 with supply/demand balances pointing to medium-term deficits. Werecently revised iron ore forecasts, including upgraded lump premiums andwider low grade discounts, in our 5 Oct. note, Global Iron ore sector- Highgrade to stay warm over winter. With the introduction of Chinese steelproduction cuts over heating season (Nov to March), we forecast 62% Fe ironore prices retracing into the US$50-60/t range (US$55/t for 4Q17), then arecovery to US$70/t by mid-2018. On aluminium (Global Aluminium Sector-Market tightening on China cuts, 12 Sept.), we expect the global aluminiummarket to shift into material deficits in 2H17 through to 2019, with smeltercurtailments in China and supply discipline from ex-China producers. Weexpect prices to be well supported until the end of the Chinese heating seasoncuts in March 2018, and forecast 94c/lb in 2018.
We have downgraded our 2017sector earnings by an average 3-4% and havelowered NPVs by an average 2%. The largest EPS downgrades are to BHP (-6%FY17, -16% FY18, mostly on lower oil prices), FMG (-22%, -36%, mostly onlarger Fe product discounts), OZL (-12%, -15%, lower copper price), and IGO (-18% in FY18, lower nickel price). Largest changes to NPV are FMG (-16% toA$4.83/sh), S32(+8% to A$2.64on higher aluminium and alumina prices),AWC (+12% to A$1.84on higher alumina prices) and WSA (-8% to A$2.19/shon lower nickel prices). Sector FCF remains strong (average FCF yield is 11% in2017) and average sector gearing will decline from 19% in 2017to just 11% in2018on our forecasts. We continue to think that growth and M&A (globally)will be back on the agenda sometime in 2018. Our Top Pick of the bulksremains RIO (0.8xNPV, 13% FCF yield), which has the best balance sheet (subUS$5b ND end of 2017), production growth (+10% over the next 5years), andongoing capital management. We also like MIN (0.8xNPV, strong lithium andcrushing earnings to offset weaker iron ore, net cash, 3x EBITDA). In base andprecious metals, we rate EVN, SBM, AQG, DCN and SFR a BUY and NCM, NSTand RRL a SELL. We have upgraded AWC to a HOLD (c. 1xNPV) anddowngraded NST to a SELL on valuation (1.15xNPV).
Top Picks; RIO, BHP, SBM, SFR, SYR, AQG. SELLs; ILU, NCM, NST, RRL, WSA.
Valuation and sector risks
We have upgraded our 2017 sector earnings by an average 2% (CY/FY18:15%), and have increased NPVs by an average 2%. The largest EPS upgradesare to BHP (+26% FY18, mostly on met. coal and copper), S32 (+28% FY18 onmet. coal, alumina and base metals), RIO (+10% 2018 on met. coal andcopper), and copper names OZL and SFR (+22% and +26% respectively inCY/FY18). Key changes to NPV are BHP (+4% to A$29.5/sh) & RIO (+3% toA$79.5/sh) on met.coal and copper. Sector FCF remains strong (average FCFyield is c.10% in CY/FY18) and average sector gearing will decline from 16% in2017 to just 12% in 2018 on our forecasts. We continue to think that growthand M&A (globally) will be back on the agenda sometime in 2018. Our TopPick of the bulks remains RIO (0.8xNPV, 13% FCF yield), sector leadingproduction growth, and ongoing capital management. We also rate BHP aBUY, with our thesis predicated on delivering a revamped strategy to increasegroup returns. In base and precious metals, we rate SBM, SFR, AQG and DCNa BUY and NCM, NST, RRL & WSA a SELL. We have upgraded OZL,downgraded OGC and IGO to HOLD on valuation (c. 1xNPV), and downgradedWSA to SELL on valuation (1.2xNPV).
Our PT’s are set broadly in-line with our DCF derived valuations. Companyrisks include adverse commodity and currency movements (p31). This reportchanges price targets and estimates for several companies under coverage; fordetails, please see Figure 2and Figure 3.