Deutsche Bank Markets Research Australasia Australia M&M - Diversified Resources Industry Australian Mining Sector Date 6 July 2016 Recommendation Change 3Q16 commodity review: sector appears fully valued Restarts and new low cost supply to limit commodity price advance in 2H ________________________________________________________________________________________________________________ Deutsche Bank AG/Sydney Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 057/04/2016. Paul Young Research Analyst (+61) 2 8258-2587 paul-d.young@db.com Mathew Hocking Research Analyst (+61) 2 8258-2611 mathew.hocking@db.com Tim Hoff Research Associate (+61) 2 8258-1424 tim.hoff@db.com Key Changes Company Target Price Rating AQG.AX 3.70 to 4.00(AUD) Hold to Buy BHP.AX 19.00 to 21.30(AUD) - EVN.AX 2.00 to 2.20(AUD) Buy to Hold FMG.AX 2.75 to 3.35(AUD) - MIN.AX 8.50 to 8.10(AUD) - NCM.AX 11.30 to 13.00(AUD) - NST.AX 2.80 to 3.40(AUD) - OGC.AX 3.40 to 3.60(AUD) - ORE.AX 4.60 to 4.40(AUD) Buy to Hold OZL.AX 4.60 to 4.50(AUD) - RIO.AX 54.20 to 55.00(AUD) - RRL.AX 2.10 to 2.30(AUD) - S32.AX 1.60 to 1.75(AUD) - SBM.AX 1.80 to 2.20(AUD) - SFR.AX 7.00 to 6.60(AUD) - SYR.AX 7.60 to 7.40(AUD) - WHC.AX 1.00 to 1.25(AUD) Buy to Hold WSA.AX 2.00 to 1.90(AUD) - ILU.AX 5.70 to 5.90(AUD) - Source: Deutsche Bank Top picks Rio Tinto (RIO.AX),AUD47.77 Buy Sandfire Resources NL (SFR.AX),AUD5.39 Buy Syrah Resources (SYR.AX),AUD6.08 Buy Source: Deutsche Bank Commodity prices are being supported by strong demand from China, mostly property and infrastructure related after strong credit stimulus, combined with the outlook for a temporary weaker USD. While we think Chinese demand may surprise in 2H, we have seen significant restarts of high cost iron ore, alumina and aluminium supply, and think the recent rally will run out steam in 4Q. The outlook for 2017 appears far more challenging, with most commodities with the exception of zinc and nickel in oversupply. There remain some compelling FCF stories in the Australian mining sector, but most stocks now appear fully valued on a DCF basis. Our Top Picks are RIO, SFR and SYR. Cautious on iron ore, aluminium and copper; constructive on coal, gold, nickel After our recent trip to China, we now expect Chinese apparent steel demand to increase by 3.5% in 2016 but then fall by 3.8% in 2017. We expect the iron ore price to hover around US$50/dmt in 3Q, but then weaken to US$44/dmt in 4Q due to a pick-up in shipments from Australia and Brazil, a further increase in “non-traditional” supply, and seasonally weaker demand. However, we acknowledge that Chinese demand might surprise well into 2H due to strong credit supply and the lag effect from property starts and infrastructure stimulus. Copper should move into oversupply in 2H and we expect prices to average c. US$2/lb for the next two years. The alumina price should weaken further to US$235/t, and perhaps lower, due to 5Mtpa of Chinese restarts and a further reduction in the equilibrium price in China. Seaborne bauxite is also moving into oversupply. We have upgraded our 2016 gold price forecast by 8% and now forecast an average US$1,340/oz in 2H. The gold price should be well supported by a less constructive monetary policy climate. Coal prices should continue to be well supported by the Chinese 276 day supply side reform policy and a pick-up in Indian and Chinese thermal coal imports. Zinc and nickel should end 2016 in deficit and we expect prices to improve further over 2H. We remain cautious on mineral sands due to new zircon supply from smaller players and significant latent TiO2 feedstock capacity. Earnings upgrades for iron ore and gold stocks, but stocks appear fully valued We have upgraded our 2016 and 2017 gold and iron ore sector earnings by an average 15-20%, but have downgraded earnings for most of the remaining companies. While acknowledging that some stocks still appear attractive on a FCF basis (MIN, FMG, S32, WHC all +8% FCF yield) we believe these stocks are relatively fully valued on a DCF basis trading at between 1-1.2xNPV. The gold sector appears expensive trading on an average 1.5xNPV based on our c. US$1,300-1,350/oz flat gold deck and weakening AUD profile. Of the gold stocks, NCM, NST, RRL SBM, OGC are the most expensive and are rated SELL. We are downgrading ORE, WHC and EVN to a HOLD after their recent strong performance. Our Top Picks (BUYs) are n