Goldman Sachs has been running the rule over the Australian mining sector and is feeling very positive.
The broker believes that the current commodity up-cycle is different from the last two commodity booms. It notes that the 2003-2007 super cycle was driven by demand growth from China coupled with a slow supply response from the mining sector after decades of low supply growth. Whereas the 2009-2011 boom was driven by a post-GFC demand rebound but then a strong supply response.
On this occasion, Goldman believes things will be different.
Its analysts explained: “Five years of mining sector deleveraging and capital discipline from 2015-2021 and a lack of high-quality greenfield projects across most commodities, the rapid emergence of decarbonisation capex by the major miners, and ongoing challenges of permitting new projects, set this cycle up as more supply-side driven over the medium term before switching to more demand driven from 2025 with increased global investment in green capex.”
In light of this positive commodity price backdrop, the broker expects free cash flow and earnings per share growth will remain strong in the Australian mining sector. This is even in the face of increasing opex and capex inflation.
Goldman also highlights that a lot of value can be found in the sector at current levels.
“From a valuation perspective, the sector is trading on an attractive 4x NTM EBITDA but at 1.05x NAV, although we note that in the 2003-2007 and 2009-2011 commodity bull markets, most stocks (diversified miners and pure plays) traded at premiums to NAV, indicating the sector can move higher,” it explained.
But which mining shares should you buy?
Its analysts commented: “We are Buy rated on RIO trading at 0.9x NAV and discounting a long run iron ore price of US$62/t (vs. GSe long run of US$67/t real) and trading on a FCF yield of 12% in 2022E (based on our US$110/t Fe forecast for 2022) and our view that RIO will return to production growth in mid-2022 on higher iron ore and copper volumes.”
The broker has a $125.60 price target on Rio Tinto’s shares.
As for South32, Goldman said: “We are Buy rated on S32.AX (on Conviction List) with strong FCF (19% base case for FY22), exposure to base metals (aluminium & alumina c. 50% of FY22 EBITDA; we are bullish aluminium on a multi-year view, zinc/nickel c. 20%), and earnings upside from the Sierra Gorda copper acquisition (c. 15% upside to our EBITDA; not in our numbers pending deal completion; expected 1Q22).”
Goldman has lifted its price target on South32’s shares to $4.70.
One mining share that the broker thinks investors should avoid is Fortescue Metals Group Limited (ASX: FMG). This is due largely to its current valuation, which Goldman feels is excessive compared to peers.
It explained: “We remain Sell rated on FMG on relative valuation (1.8x NAV) and trading at a significant premium to BHP & RIO on a EV/EBITDA basis (5.4x vs. BHP & RIO on c. 4x), low grade iron ore price risk (GSe 68% price realisation for Dec Q), low FCF yield (3-5%) vs. BHP & RIO (10-12%) and capex and execution risks on the Iron Bridge & FFI set of projects.”
The broker believes the Fortescue share price is only worth $13.50 today. This implies significant downside from current levels.