Despite an expected drop in global demand over the next 12 months in line with the fall in global economic indicators, plus cost inflation and rising energy and labour costs, Goldman Sachs remains positive on commodities and the Australian mining sector over the medium term.
Regardless of these headwinds, the broker believes the mining sector remains undervalued trading at around 0.8x net asset value (NAV).
While free cash flow (FCF) remains strong on a FY23 average of around 12%, dividend yields are expected to be around 12%, 10% and 8%/7% in FY23, FY23 and FY24 respectively.
The broker also points to a second half recovery in China infrastructure property construction and expects global decarbonisation/green capex to result in base metal market deficits.
Goldman’s reminds investors that with metals currently trading on macro sentiment, traditional inventories, unit flow and cost curves are largely irrelevant in dictating short run price.
Goldman’s doesn’t expect the market to refocus back to micro fundamentals, unless there’s sufficient conviction in the efficacy of Chinese stimulus - expected over the course of third quarter - an end to aggressive Fed rate hikes or a complete stock out.
Meantime, while Goldman’s has cut near term pricing across aluminium, copper and iron ore, the broker expect fundamental dominance to emerge over the next 12-18 months, hence supporting pricing.
Of the 17 mining and steel stocks under coverage, the broker favours companies trading below or around NAV and with either strong FCF and/or high production and earnings growth.
These favoured stocks include BHP (ASX: BHP), Rio Tinto (ASX: RIO), South32 (ASX: S32), Coronado (ASX: CRN), Whitehaven Coal (ASX: WHC), BlueScope Steel (ASX: BSL), Iluka Resources (ASX: ILU), Mineral Resources (ASX: MIN) , and Champion Iron (ASX: CIA).
Goldman’s maintains a Sell rating on Fortescue Metals (ASX: FMG), Alumina (ASX: AWC) and New Hope (ASX: NHC) on relative valuation.
The broker has downgraded Oz Minerals (ASX: OZL) to Neutral from Buy based on a near term copper price outlook and the weak production and FCF outlook over the next 2-3 years.
High grade iron ore miner Champion Iron has been upgraded Buy from Neutral on both valuation and a FCF inflection point from the ramp-up of the Bloom Lake Phase 2 project to 16Mtpa.
But based on lower near term iron ore forecasts, adjusted high grade realisations, unit costs, freight rates, and updated provisional pricing, the broker has adjusted its FY23-FY24 earnings per share (EPS) -7% and -19% respectively.
As a result, the NAV is down-8% to $7.06 from $7.64 and the 12-month price target is down -8% to $7.30 from $7.90.
Due to higher costs and lower revenue in FY23, and improving pricing in FY24, the broker’s underlying earnings (EBITDA) forecasts for FY23 and FY24 are circa -17% and circa 3% versus consensus.
Goldman’s has upgraded Champion on the back of:
Doubling production of high-grade Fe, strong FCF yield from FY23: The company ended the March quarter in a slight net debt position and declared a final dividend of C10cps and the broker expects a strengthening net cash position in FY23.
Kami acquisition could underpin a Phase 3 expansion: Champion is currently evaluating Phase 3 at Bloom Lake, which would be underpinned by the recent Kami acquisition, with the feasibility study currently being redone with results expected in second half 2022.
Valuation: The stock is trading at circa 0.7x NAV versus coverage average of circa 0.8x NAV. The Kami expansion or the high-grade project are not captured in the broker’s base case until project study outcomes have been released.
However, Goldman’s has included a nominal CAN$500m for growth optionality in its NAV.
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