Ground Breakers: Goldman Sachs says big miners are in buying territory (unless they're owned by Twiggy)

Think the boom is over for Aussie miners? Think again.

Goldman Sachs says the major mining stocks are big buys right now, with BHP (ASX:BHP), Rio Tinto (ASX:RIO) and South32 (ASX:S32) all undervalued as the investment bank eyes bullish conditions for commodities in 2022.

But it has added its voice to a chorus, including Morningstar, RBC and Citi who see Andrew Forrest’s Fortescue Metals Group (ASX:FMG) as overvalued relative to BHP and Rio and issued a hard sell notice on the stock.

Goldman’s Paul Young estimates Twiggy’s mob will have to spend US$7 billion on decarbonisation capex to meet their climate action aims in the Pilbara, and will need to cut dividend payouts from 80% of profits to 50% going forward to support its green energy business, Fortescue Future Industries.

Paved with gold, how this boom will be different from the last

Goldman has been one of the more bullish traditional investment banks on commodities in recent years, expressing optimism about metals demand driven by decarbonisation and renewable energy infrastructure in the coming years.

Young said the set up for commodities and the Aussie mining sector is positive in 2022.

“An expected stabilisation and modest recovery in Chinese construction activity (infra & property) post CNY, further broad improvement in RoW demand, structural supply shortages and low inventories across most commodities and rising inflation/pressure on cost curves are positive for commodity prices in 2022 in our view,” he said.

“We remain most positive on base metals and expect the iron ore market to tighten in 2Q.”

Goldman predicts iron ore will average US$110/t this year, well above more bearish forecasts from the Aussie Government, big banks, Capital Economics and UBS. Goldman’s estimate for the June quarter is higher still at US$125/t due to seasonal weakness in Brazilian and Australian production and rebounding Chinese steel output.

And this time the up-cycle is different.

“We continue to see this commodity up-cycle as different from the last two commodity booms,” Young said.

“The 2003-2007 super cycle was driven by ~10% annual demand growth from China, coupled with a slow supply response from the mining sector after decades of low supply growth,” he said.

“The shorter 2009-2011 boom was driven by a post-GFC demand rebound but then a strong supply response, which resulted in mining sector capex, costs and gearing hitting record highs.

“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.”

The case for the big boys (barring you know who)

Goldman’s argument against Fortescue, which has risen 15.6% over the past month to a four month high of $21.34 per share, is that it is priced at a premium to the other iron ore stocks.

While BHP and Rio’s share prices factor in Goldman’s long run iron ore price of US$67/t, he said FMG is pricing in a long run estimate of US$84/t. While FMG is trading on a 5.4x EV/EBITDA basis and a big premium of 1.8x NAV, BHP and Rio are hovering around the 4x mark.

Young said the sector in general is trading at 1.05x NAV, but could go higher based on previous cycles.

“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,” he said.

“The major diversified miners appear undervalued trading on around 4x EBITDA relative to historical multiples of 6-7x, and on FCF (free cash flow) yields of 11-12%, which is below the 15-yr historical average of 7-8%. We forecast an attractive average sector dividend yield of 8%/6% in FY22/FY23 despite increased spend on growth and decarbonisation.”

Goldman does not have a rating on BHP, but holds a buy and $125.60 share price target on Rio Tinto, with a sell rating and $13.50 price target on FMG.

Young expects a further blowout in FMG’s Iron Bridge budget and timeline this year, overshooting its US$3.3-3.5b capex estimate to US$3.7b and delivering first ore a quarter late in March 2023.

He also says price realisation for FMG’s low grade fines will widen on the benchmark 62% iron ore price.

“We see FMG’s price realisations dropping to 68% in Dec Q (from 73% in the Sep Q) and expect FMG to report a net debt position of c. US$2bn at end of Dec 2021.”

Big boys share price today:

Who else is on Goldman’s radar?

BUYS

Goldman’s Young is also bullish on Champion Iron (ASX:CIA).

The ASX’s largest high grade iron ore producer with its Bloom Lake complex in Canada is aiming to ramp up to a run rate of 15-16Mtpa from March 2022, double its current production levels.

Goldman estimates Champion is trading on 3.5-4x EBITDA.

South32 (ASX:S32) ($4.70PT) is on Goldman’s Australia-New Zealand “conviction list”. Young says its earnings per share will rise by 18% in FY22 and 8% in FY23 on higher commodity prices. Goldman is positive on base metals and South32 has the whole suite of them, including aluminium, alumina, copper, nickel and manganese.

Coal miners Coronado (ASX:CRN) ($1.80PT) and Whitehaven Coal (ASX:WHC) ($3.60PT) are also buys on the back of upside to coal prices.

Mineral sands miner Iluka Resources (ASX:ILU) ($12.40PT) has been placed on Goldman’s conviction list. Young said Iluka has compelling mineral sands and rare earths growth potential (the latter of which he says the market is only ascribing some value to) and that there is upside risk to zircon prices in 2022.

“The c.1.05Mt global zircon market entered a deficit in 2021 on our estimates, driven by a >10% fall in global supply on mine depletion and production cuts, and a strong rebound in global demand for ceramics,” he said.

“The Top 3 global zircon producers control 65%-70% of supply. ILU announced in August a further US$120-170/t zircon price increase from 1 October, which should increase ILU’s realised price to around US$1,450/t (FOB, all products including Zircon-in-Concentrate).”

NEUTRALS

Coal miner New Hope Corp (ASX:NHC) ($2.30PT), premium priced copper miner Oz Minerals (ASX:OZL) ($28.40PT) and aluminium stock Alumina (ASX:AWC) ($2.10PT) are all rated as neutral.

Iron ore royalty play Deterra Royalties (ASX:DRR) ($4.50PT) has also been downgraded from buy to neutral.

SELLS

While Goldman is generally positive on mining stocks it has whacked a sell on copper miner Sandfire Resources (ASX:SFR) ($6.10PT), however it has not included the 110,000tpa MATSA copper mine in Spain in its valuation yet, with the $2.6 billion deal expected to close at the end of this month.

“Our Matsa valuation scenario is based on a ~12 year reserve life (on typical resource disclosure, per SFR, and GSe assumption of 50% conversion of resources to reserves which we see as comparable to similar deposits) with increased production to 4.5Mtpa by FY23E (from 4.2Mtpa now), which is more conservative than SFR’s target of 4.7Mtpa due to our view of the challenging metallurgy (variable metallurgy, recoveries and concentrate quality) and geology,” Young said.

However, Goldman is positive on Sandfire’s core commodities and said it could see upside from a faster than expected ramp up of MATSA and any exploration success at its MATSA, Motheo or DeGrussa mines.

“We are positive on copper (US$5.4/lb in 2022 vs. spot at US$3.4/lb),” Young said.

“A rally in both copper and zinc prices on further market tightness (low inventories, power cut impacts in Europe on smelters, and recovering demand) would be positive for SFR, along with a weaker AUD.”