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Goldman Sachs adds this ASX 200 mining stock to its conviction buy list

Our market may be making a comeback today but the optimism isn’t extending to the mining sector, which is one of the few areas of the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index that is wallowing in red.

The ASX 200 jumped 0.5% higher in after lunch trade when the BHP Group Ltd (ASX: BHP) share price is down 0.7% at $31.20, South32 Ltd (ASX: S32) share price lost 1% to $3.09 and OZ Minerals Limited (ASX: OZL) share price shed 3.9% to $8.31.

Ongoing worries about a slowdown in China’s economic growth and the global trade war is adding downward pressure on the sector, which has already gained the dubious honour of being the worst performing part of the S&P/ASX 200 in the past month or so.

Latest addition to the “conviction list”

But the weakness, particularly among the bulk commodity producers, represents an excellent buying opportunity, according to Goldman Sachs.

The broker is so convinced in the outlook for the sector that it has added BHP to its “conviction list” of stocks it’s urging investors to buy.

“We now expect net debt to fall below management’s US$10-15bn target range by February 2019,” said Goldman.

“We add BHP to our Conviction List due to its favourable commodity mix (we are most positive on oil), superior margins (c.55%), non-core divestment potential, oil exploration upside and likely further share buybacks from February 2019 onwards.”

Next catalyst for ASX miners

The market may take a while to feel the same enthusiasm towards miners like BHP given the volatile macro-economic outlook, but the February reporting season could change all that as Goldman thinks the next profit reporting season will be a positive catalyst for the sector.

This is thanks to the strong balance sheets of our big miners, including Rio Tinto Limited (ASX: RIO), and their robust free cashflow generation that isn’t encumbered by debt.

What’s more, the sector is trading on an average enterprise value-to-earnings before interest, tax, depreciation and amortisation (EV/EBITDA) of around 4.5 times, which is a 25% discount to its historical average.

This valuation discount isn’t justified even though the drop in the iron ore price due to poor Chinese steel mill profits is rattling investors.

Is the worst over?

The significant margin squeeze on Chinese mills (a major consumer of iron ore) is driven by a less stringent government mandated cut to production and an oversupply of steel.

“While parts of the Chinese economy are likely to remain soft over the next few months, our China economists believe we are now near the ‘data trough’,” said Goldman.

“We expect commodity fundamentals will remain positive in 2019 on solid demand and ongoing supply-side discipline.”

Other ASX mining shares Goldman likes (but not on its conviction list) include Coronado Global Resources Inc (ASX: CRN) and Alumina Limited (ASX: AWC).

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Motley Fool contributor Brendon Lau owns shares of BHP Billiton Limited, Rio Tinto Ltd., and South32 Ltd. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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