Australia Mining Sector:3Q17commodity review,the cash cow sector
Downgrading sector earnings 3-4% but FCF yield remains at +10%
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;
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.
Top Picks; RIO, EVN, SFR, SYR, MIN, SELLs; ILU, RRL, NCM, RRL, NST
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).
Valuation and sector risks
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.
