European Mining 2018Outlook:Upside remains,a guide to 2018-GLEN,RIO and FM top picks

Further re-rating potential despite slowing demand

    After two years of outperformance we still see further upside (>25%) for selectivenames. We cover four key themes that we think will be critical in 2018: thecycle, copper, costs and capital. Top picks: RIO (leading cash returns), GLEN(undervalued growth, base metal exposure) and FM (de-risking of project pipelinein 2018). Sells: NHY, ANTO, S32. We also upgrade Anglo from SELL to HOLD.

    Cycle outlook: seasonality strongly in favour

    Chinese demand is slowing, but this now appears the consensus view and pricedin. We expect slower demand in 2018but no collapse, the supply side remainssupportive and consensus estimates need to increase (DB EBITDA ~10% ahead).On a seasonal basis, Nov-Apr is the strongest period from a commodity pricingand sector performance perspective; over the past 20years,the average absolutereturn for mining equities Nov-Apr is 11%. Steel production troughs in Q4andrebounds through H1; Chinese policy measures to control pollution through thewinter could amplify this trend in 2018.

    Copper: supply challenges 2018-20

    Copper is our preferred metal exposure and we have laid out the supply challengesfacing the industry 2018-20, including labour, country and project risks. Weforecast 297c/315c in 2018/19, ~10% above consensus.

    Cost inflation returning in 2018

    We have undertaken a detailed analysis on current and historical cost trends.While cost pressures are far less severe than the 2004-2012period, we expectindustry costs to be up >5% in 2018through a combination of FX, oil and otherinput cost and labour inflation. While inflating cost curves are positive for prices,there is a risk consensus may not have fully factored this in. We see the biggestcost push in aluminium and we recently downgraded both NHY and S32to SELLdue to high cost pressures.

    Capital allocation will be under close scrutiny in 2018

    The market is becoming more receptive to selective growth, but maintaining adisciplined approach will be key for sentiment. M&A is a clear risk factor. Weexpect large cap capex to increase >10% in 2018, but will still be someway belowour normalised estimates. We think mid cycle FCF yields of 8-11% are deliverable;

    if translated to a ~5% dividend would make the sector one of the most attractiveyielding in the market.