Goldman Sachs just upgraded this ASX 200 stock to a buy

It sees the recent sell-off as an overreaction – and an opportunity.

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It's that time of year again when investors check their leaders and laggards and potentially rotate into cheap ASX 200 stocks. Analysts have already started the process.

Deterra Royalties Ltd (ASX: DRR) has caught Goldman Sachs' attention. In a Tuesday note, the broker revised its rating on the ASX 200 stock from a hold to a buy.

Goldman's note puts it out of sync with the consensus rating of hold, per CommSec.

Deterra on the other hand has opened Wednesday's session at $4.10 apiece, up 1.87%. This produces a dividend yield of 7.29% with its trailing dividend of 30 cents per share.

Here's a closer look at the reasons behind Goldman's revised rating.

Goldman upgrades ASX 200 stock

Goldman Sachs has revised its forecasts on Deterra's earnings per share (EPS) for FY24-26 by 2% in both years based on a better iron ore and forex outlook.

It also notes the large sell-off of the ASX 200 stock following management's decision to acquire Trident Royalties Plc for $276 million. This, it says, could mean the stock is undervalued.

The market initially reacted negatively, with a sharp drop in share price. This was possibly furthered by Deterra's decision to alter its dividend policy. Moving forward, it will move from paying 100% of net profit after tax (NPAT) to a minimum of 50%.

However, Goldman Sachs believes this move positions Deterra for long-term growth, backed by its strong balance sheet:

[U]ndervalued: The stock is trading at ~0.8x NAV, and pricing in ~US$64/t 62% [iron ore] Fe vs. spot at ~US$105/t and our long run US$78/t (real $, from 2028) 62% Fe iron ore price forecast.

Deterra is trading on c. 10x EBITDA for FY25 versus global precious in ~15x and bulk royalty companies ~5x.

The broker mentioned Deterra's approximate 7% free cash flow and dividend yield implied for FY24, which is "broadly in line with major iron ore producers". It also leaves its dividend forecast at 100% of NPAT for FY24.

Strong balance sheet

With a net cash position of $30 million and access to a $500 million debt facility, Goldman says Deterra could be well-placed to pounce on future opportunities.

[Deterra] will have ~A$30mn net cash at end of June on our estimates and has access to an A$500mn undrawn debt facility and we believe they are well positioned to capitalise on potential growth opportunities in the current high rate debt environment, including the Trident acquisition and potential other opportunities.

Aside from that, the ASX 200 stock is " less leveraged" compared to other iron ore miners "given the high margin nature of [its] royalty business".

Interestingly, Goldman analysts also took a peek at Trident's potential advantages, noting that it has a portfolio of various gold offtakes.

Based on Trident's 2023 financial result, we note underlying earnings were essentially 0 and [greater than] 60% of earnings come from the gold offtake agreements which DRR noted [it] will look to divest.

Goldman set a price target of $4.70 per share on the ASX 200 stock. This equates to a multiple of 12 times the next 12 months' earnings before interest, taxes, depreciation, and amortisation (EBITDA).

Foolish takeaway

According to some experts, Deterra's sharp sell-off in recent weeks could be an overreaction. For this ASX 200 stock, the upgrade from Goldman Sachs suggests investors are thinking long-term.

In the last 12 months, Deterra shares are down 10%. This is an underperformance of nearly 17% versus the S&P/ASX 200 Index (ASX: XJO).

Motley Fool contributor Zach Bristow has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has positions in and has recommended Goldman Sachs Group. The Motley Fool Australia has no position in any of the stocks mentioned. 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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