Goldman Sachs downgrades aluminum/nickel on back of lower European demand

While Goldman Sachs remains positive on the broader commodities outlook over the medium term, the broker has downgraded aluminum and nickel price forecasts after revising European demand lower for second half 2022 and first quarter 2023.

The broker believes demand in Europe is suffering a sudden negative demand shock with the industrial supply chain currently undergoing an aggressive destocking cycle given the extreme uncertainties over demand conditions into winter.

While weaker than expected demand in Europe could result in a fall in aluminum prices, the broker sees the alumina market as well supplied near term with restarts in Jamaica and new refineries ramping up in China, India and Indonesia over 2022 & 2023.

Non-ferrous metals forecasts

Source: Goldman Sachs.

Tough period for base metals

“We continue to think the next 2-3 quarters will be a tough period for base metals and steel as European and global demand continues to weaken and the US$ continues to strengthen,” the broker notes.

However, based on tight supply and resilient demand and/or favourable substitution dynamics, the broker believes commodities with more supportive fundamentals over the next 6-12 months include:

• High energy thermal coal

• Met coal (being diverted into thermal market)

• Rare earths (NdPr)

• Zircon and high grade TiO2 feedstock

• Copper to a degree (with ongoing Chilean mine production issues)

Australian mining sector

While there has been no visible broad recovery in Chinese construction and commodity demand, Goldmans remains upbeat on both broader commodities and the Australian mining sector over the medium term due to:

• Ongoing mining under-investment & supply side disruptions

• Fewer M&A targets making it harder for Big Miners to buy then grow

• Expected recovery in China infrastructure & property construction in 2023

• Global decarbonisation/green capex to result in base metal market deficits

• Mining sector undervalued trading at around 0.8x NAV

• Free cash flow (FCF) remains strong (FY23 average of 10%-plus) despite headwinds from rising costs and sustaining capex

Key stock calls

Within the 17 mining and steel stocks under coverage, Goldmans favours companies trading below or around net asset value (NAV) and with either strong free cash flow (FCF) and/or high production and earnings growth and remains Buy rated on:

• BHP Group (ASX: BHP)

• Rio Tinto (ASX: RIO)

• Iluka Resource (ASX: ILU)

• Coronado Global Resources (ASX: CRN)

• Blue Scope Steel (ASX: BSL)

• Mineral Resources (ASX: MIN)

• Champion Iron (ASX: CIA)

Based on relative valuation with both stocks trading at 1.5xNAV, Goldmans remain Sell rated on:

• Fortescue Metals Group (ASX: FMG)

• New Hope Corporation (ASX: NHC)

Upgrades

Royalty company Deterra Royalties (ASX: DRR) upgraded to Buy from Neutral on valuation (0.85xNAV), 6.5-8% dividend yield, upside at BHP’s South Flank mine with the ramp-up ahead of schedule, and no exposure to escalating industry opex and capex. Price target $4.70.

Alumina (ASX: AWC) upgraded to Neutral from Sell on valuation trading at 0.78xNAV ($1.67) and on a total shareholder return (TSR) of 6% versus sector average of 9%.

Goldmans notes ongoing margin & FCF pressure in second half 2022 and 2023 but declining costs into year end and a strong balance sheet. Price target $1.30.

Downgrades

Sandfire Resources (ASX: SFR) downgraded to Sell from Neutral on the back of a forecast 40% fall in earnings (EBITDA) and negative FCF in FY23, with the broker’s revised price target implying 11% downside.

Goldmans also highlights Botswana/Motheo copper mine execution risks and high energy prices and the challenging metallurgy and geology at the Matsa copper/zinc mine in Spain. Price target $3.50.

South32 (ASX: S32) Downgraded to Neutral from Buy based on a revised lower NAV valuation of $3.78 and price target of $3.70 on the back of our base metal price downgrades resulting in a modest FCF yield of just 3% in FY23E and EPS downgrades at spot commodities and FX.

However, the broker highlights a supportive dividend yield (6% in FY23), share buyback and compelling long term base metals growth.

South32 share price over 12 months.