Australia Mining Sector：2Q17 commodity review: waiting for the fall

Deutsche Bank Markets Research Australasia Australia M&M - Diversified Resources Industry Australia Mining Sector Date 16 March 2017 Recommendation Change 2Q17 commodity review: waiting for the fall Upgrading sector earnings but commodities appear overvalued ________________________________________________________________________________________________________________ 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 Matthew Frydman Research Associate (+61) 2 8258-2607 matthew.frydman@db.com Tim Hoff Research Analyst (+61) 2 8258-1424 tim.hoff@db.com Key Changes Company Target Price Rating BHP.AX 24.00 to 25.00(AUD) - S32.AX 2.70 to 2.60(AUD) - AWC.AX 1.70 to 1.65(AUD) - WHC.AX 3.00 to 2.80(AUD) - ILU.AX 5.20 to 5.00(AUD) - FMG.AX 5.50 to 6.30(AUD) - MIN.AX 10.50 to 10.80(AUD) - NCM.AX 16.90 to 18.50(AUD) - NST.AX 4.10 to 4.00(AUD) - EVN.AX - Hold to Buy IGO.AX 3.80 to 4.10(AUD) Hold to Buy SFR.AX 7.20 to 8.60(AUD) - OZL.AX 6.20 to 7.10(AUD) - SYR.AX 6.30 to 6.00(AUD) - Source: Deutsche Bank Top picks Rio Tinto (RIO.AX),AUD62.23 Buy Sandfire Resources NL (SFR.AX),AUD6.67 Buy St Barbara (SBM.AX),AUD2.63 Buy Independence Group (IGO.AX),AUD3.65 Buy Evolution Mining (EVN.AX),AUD2.15 Buy Source: Deutsche Bank We are upgrading our commodity price forecasts by an average 7% over the next two years mostly due to stronger demand from Chinese infrastructure, property and manufacturing. However, our forecasts remain below current spot levels for most metals. Swing supply is returning and restocking has run ahead of fundamentals. We believe iron ore, alumina and aluminium have the most downside risk. Despite upgrading sector earnings by 8%, we think most stocks look fairly valued on a DCF basis. Any pullback in stocks might present opportunities in our view, particularly in the iron ore names. Our top picks are RIO, EVN, SBM, SFR, IGO. Our SELL ratings are ILU, AWC, OZL, NCM, RRL. Big upgrades for copper, iron ore and coal, downgrades for nickel and gold Major upgrades to our commodity forecasts in this review are; iron ore (+22% to US$69/t in 2017, +19% to US$54/t in 2018 vs. spot US$88/t) copper (+12% to US267c/lb in 2017, +28% to US354c/lb in 2020 vs. spot US263c/lb), zinc (+10% to US140c/lb in 2017 vs. spot US124c/lb), Newcastle thermal coal (+7% to US$75/t in 2017 vs. spot US$81/t). Major downgrades are; manganese (-22% to US$4.6/dmtu in 2017 vs. spot US$4.0/dmtu), nickel (-10% to US480c/lb in 2017 vs. spot US461c/lb), and coking coal (-4% to US$193/t in 2017, +15% to US$115/t in 2018 vs. spot US$159/t). Overall we see most commodities as oversupplied and trading above both marginal cost and historical real average prices. We expect iron ore to retrace by 40% to US$50-60/t and alumina by 20% to US$270/t by the end of 2017. We continue to take a more positive view on energy, neutral to positive stance to industrial and precious metals and are generally cautious on the bulks. Top Picks (RIO, EVN, SBM, SFR, IGO), SELL (ILU, AWC, OZL, NCM, RRL). We have upgraded our 2017 sector earnings by an average 8% and have lifted NPVs by an average 3%. The largest NPV upgrades have been to SFR (+19%), OZL (+15%), FMG (+15%) and IGO (+9%). Sector FCF and de-gearing should remain strong over 2017 and capex and costs should remain under control. We think growth and M&A (globally) will be back on the agenda sometime in 2018. The Australian large cap and bulk miners are trading on an average FCF yield (OCF less capex) of c. 12% on our base case commodity assumptions. Our Top Pick of the bulks remains RIO (0.85xNPV, 14% FCF yield), which has the best balance sheet (sub US$4b ND end of 2017), production growth (+10% over the next 5 years), capital management potential, and cost out of all the major global miners in our view. We also expect FCF and de-gearing of BHP, FMG, S32 and WHC to continue to be strong, but rate these stocks HOLD on valuation (DCF). All are trading close to 1xNPV but our valuations already assume a fall in bulk commodity prices. The gold sector appears fairly valued trading on an average 1.1xNPV based on our falling near-to-medium gold price forecasts. In base and precious metals, we rate SBM and SFR a BUY and NCM, RRL and OZL a SELL. We have upgraded EVN and IGO to BUY on valuation. We rate ILU (1.3x NPV,