Ground Breakers: Goldman Sachs is still in miners' corner heading into the 2022 earnings season

Heading into earnings season Goldman Sachs says the medium term outlook for miners remains positive despite commodity demand and cost concerns
OZ Minerals downgraded to neutral, Champion Iron upgraded to a buy, GS says there’s 51% price upside with its $7.30 target
Mining and energy stocks drop on lower prices

Miners have weathered more bad news than Job in the past couple of months.

Unless you’re in coal the endless cycle of rate rises, high inflation prints and bearish Chinese economic data has stymied enthusiasm in the sector.

Lower copper, nickel, gold and iron ore prices (hitting a 2022 low of US$106.05/t) hit the market overnight, with oil also sliding on demand concerns over fresh Covid cases in China.

Materials stunk again this morning, down 0.85% while the drop in oil prices sent energy stocks 1.42% lower.

It’s not the greatest backdrop for the onrushing earnings season, which is expected to come with a flurry of production numbers, profits and dividend payments.

But bankers over at Goldman Sachs say there are a host of reasons to keep backing the miners even under the looming threat of recession.

Commodities trading on sentiment as bearish mood bites

According to Goldman Sachs mining analysts Paul Young and Hugo Nicolaci, metals are currently trading with falling market sentiment, with inventory and cost curve analysis “broadly irrelevant” in the short term price.

That has led GS’ global commodities team to cut near term aluminium, copper and iron ore pricing before fundamentals begin coming to the fore over the next 12-18 months.

There are few surprises that investors GS speaks to are most bullish on energy commodities in the wake of the Russia-Ukraine war and subsequent sanctions as well.

“Our recent 2-week offshore marketing roadshow across Singapore, London, and the US, meeting with >50 investment funds and numerous mining companies and commodity traders, indicated that investors are most positive on energy (thermal coal, natural gas etc) and most bearish on steel, copper and aluminium on an expected global economic slowdown in 2H22, with few investors willing to take a positive view on a recovery in Chinese construction and commodity demand,” they said in a note this week.

GS retains its structural bull story on copper, with long term prices of US$6.40-6.80/lb (well beyond record levels) in 2024 and 2025, but has reduced its short term forecasts to US$3.84/lb in 2022 and US$4/lb in 2023.

It also sees iron ore as the biggest downside risk for stocks heading into the third quarter on potential surpluses from rising Australian and Brazilian supply, its continued premium to the top of the costs curve and concerns Chinese infrastructure projects will focus on developments with a lower steel intensity than previous stimulus measures.

Despite all this, Australian analysts Young and Nicolaci say the outlook for Australian miners remains positive despite concerns about falling global commodity demand over the next 12 months and inflation due to rising energy and labour costs.

Mining sector ‘undervalued’

Mining stocks have suffered a major pullback since the start of a wave of Covid lockdowns in China three months ago.

GS estimates the sector is trading at just 0.8x NAV, with average free cash flow across its listed picks of 12% in FY23 and dividend yield of 10%.

“Within our 17 mining & steel stocks under coverage, we continue to favor companies trading below or around NAV and with either: 1. strong FCF and/or; 2. high production and earnings growth (BHP, RIO, S32, CRN, WHC, BSL, ILU, MIN, CIA),” Young and Nicolaci said.

It remains unchanged on its bullish medium term stance on Australia’s resources players, with Young and Nicolaci citing underinvestment and supply disruptions, a dearth of M&A targets, Chinese economic recovery, green investment in base metals and the aforementioned gulf between NAV and market cap for most of the majors.

Champion Iron upgraded to a buy

While the outlook is clouded for many of the majors and copper-gold miner OZ Minerals (ASX:OZL) has been flipped from a buy neutral on a weaker copper price outlook and production outlook, Young and Nicolaci have flipped one miner to a Buy.

Enter stage left Canuck iron ore producer Champion Iron (ASX:CIA).

GS views CIA, which owns the high grade Bloom Lake magnetite mine in Canada, as undervalued (0.7x NAV v 0.8x across the sector) and with a free cash flow inflection point as it ramps up a stage 2 expansion at Bloom Lake this year to 16Mtpa.

While CIA’s price target has been cut 8% from $7.90 to $7.30/share on lower iron ore prices and increased costs, the $2.5b capped miner is currently going for $4.77, with GS saying its 51% upside outstrips the average of 25% across the market.

Iluka Resources (ASX:ILU) could also surprise to the upside on stronger mineral sands pricing.

That contrasts to the cost pressures Young and Nicolaci expect will pervade industry reports this quarter, with the investment bank’s cost forecasts for FY23 and FY24 sitting 10% above the market consensus.

“Companies with the greatest risk of higher than expected opex & capex in our view are more the underground miners and those with downstream assets (refineries/smelters),” they said.

“We think ILU could surprise positively on zircon prices (+US$150/t or +7% from 1 July) and possibly rutile (+US$100/t from 1 July according to Chinese price assessors).”