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Metals & Mining

Slowdown could present opportunities

vk.com/id446425943

 

Sector update

 

 

 

 

Equity Research

 

 

 

 

 

14 January 2019

 

 

 

 

 

Metals & Mining

 

 

 

 

 

 

Global

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Johann Pretorius

 

 

 

 

 

 

+27 (11) 750 1450

 

 

 

 

 

Metals & Mining

JPretorius2@rencap.com

 

 

 

+27 (11) 750 1481

 

 

 

 

 

 

Steven Friedman

 

 

 

 

 

Slowdown could present opportunities SFriedman@rencap.com

 

 

 

 

Kabelo Moshesha

 

 

 

 

 

We have a neutral outlook on the metals & mining sector overall.

+27 (11) 750 1472

 

 

 

 

 

KMoshesha@rencap.com

 

 

 

We believe a cyclical slowdown in commodity demand could

Siphelele Mhlongo

 

 

 

 

 

weigh on near-term prices. However, underinvestment in new

 

 

 

 

 

+27 (11) 750 1420

 

 

 

 

 

supply could support commodity prices over the medium term.

SMhlongo@rencap.com

 

 

 

Most management teams remain focused on value-creation

Derick Deale

 

 

 

 

 

 

through efficiency and productivity gains, rather than embarking

 

 

 

 

 

 

+27 (11) 750 1458

 

 

 

 

 

on value-destructive volume growth. We believe most commodity

DDeale@rencap.com

 

 

 

prices are only around mid-cycle levels and company valuations

Charles Robertson

 

 

 

 

 

are undemanding. Our revised commodity price and currency

 

 

 

 

 

+44 (207) 005 7835

 

 

 

 

 

forecasts result in minor adjustments to our TPs for a number of

CRobertson@rencap.com

 

 

 

 

 

 

 

 

 

 

 

miners (details in Figure 2). We downgrade our rating on Anglo

 

 

 

 

 

 

 

 

American to HOLD following its share-price recovery, given a

Summary sector ratings and TPs (ranked by total

rising capex profile and due to our near-term commodity demand

potential 12M return, including estimated dividends)

 

Company

TP

Previous Current

Rating

concerns. Our top picks are the Russian steel producers, Norilsk

 

TP

price*

 

 

 

 

 

 

Nickel, Polyus Gold and Exxaro.

Evraz, GBp

 

620

 

620

475

BUY

 

Norilsk, $

24.0

 

24.0

20

BUY

 

 

Near-term economic growth concerns…

Severstal, $

 

17.1

 

17.1

14

BUY

 

Merafe, ZAR

1.6

 

1.6

1.4

BUY

 

NLMK, $

 

26.4

 

26.4

23

BUY

 

We remain concerned about the potential negative impact of a trade war on the

Fortescue, AUD

5.4

 

5.4

4.5

BUY

Rio Tinto, GBP

 

46.0

 

46.0

38

BUY

 

 

 

 

 

global economy. Interest rates have been rising against the backdrop of high global

Polyus, RUB

6,300

 

6,300

5,287

BUY

debt levels. Falling equity markets have already provided a warning of slower global

Exxaro, ZAR

 

150

 

160

134

BUY

 

MMK, $

9.6

 

9.6

8.4

BUY

growth expectations. We lower many of our near-term commodity price forecasts to

 

ARM, ZAR

 

150

 

150

136

BUY

 

reflect our expectation of an economic slowdown, which reduces our earnings

 

 

 

Alrosa, RUB

109

 

106

102

BUY

forecasts for some miners and results in slightly lower TPs (Figure 2). Mining

Impala, ZAR

 

45

 

45

38

BUY

 

companies have significantly deleveraged their balance sheets since 2015, and we

Vale, $

15.5

 

15.5

14

BUY

South32, ZAR

 

37

 

37

33

HOLD

 

believe comfortable balance sheets position them better for a cyclical downturn. Gold

 

 

 

Glencore, ZAR

55

 

60

50.7

HOLD

 

 

producers will likely outperform other miners in a global risk-off environment. Polyus

Assore, ZAR

 

300

 

320

294

HOLD

 

is our top pick among gold producers.

BHP, ZAR

300

 

310

297

HOLD

AMSA, ZAR

 

4.2

 

4.2

3.8

HOLD

 

 

 

 

 

…but underinvestment in new supply supports rising returns…

Anglo, ZAR

320

 

340

312

HOLD**

Polymetal, GBP

 

8.6

 

8.6

8.7

HOLD

 

 

Sibanye, ZAR

11.1

 

11.1

11

HOLD

We believe sector capex has been cut to a level that could result in supply deficits

Amplats, ZAR

 

540

 

540

549

HOLD

 

Northam, ZAR

40

 

40

43

SELL

 

 

over the medium term. Capex/depreciation, which averaged around 2x over the past

Kumba, ZAR

 

220

 

220

275

SELL

 

16 years, is still only at around 1x, which is not enough to replace depleting mines, in

RBPlats, ZAR

25

 

25

28

SELL

our view. We therefore forecast mine production to decline over the next 10 years.

Gold Fields, ZAR

 

43

 

43

51

SELL

 

Harmony, ZAR

21

 

21

27

SELL

 

 

This could underpin rising commodity prices and sector returns over the medium

Lonmin, ZAR

 

7.0

 

7.0

9.1

SELL

 

term. Undemanding mining company valuations could favour sector consolidation

AngloGold, ZAR

110

 

110

181

SELL

over investment in new supply, which could be share-price-supportive.

*Priced at market close on 7 January 2019.

 

 

 

**Previously Buy.

 

 

 

 

 

 

Source: Thomson Reuters Datastream, Renaissance Capital estimates

…and management remains focused on value-creation

Management teams continue to focus on value-creation through productivity, costcontainment and capital efficiency rather than volume growth, which is often valuedestructive. Many miners are now highly FCF-generative, despite our view that commodity prices are only around mid-cycle levels and supported by industry costs. We believe a potential pullback in share prices due to a cyclical slowdown could therefore present a buying opportunity from a medium-term perspective.

Important disclosures are found at the Disclosures Appendix. Communicated by Renaissance Securities (Cyprus) Limited, regulated by the Cyprus Securities & Exchange Commission, which together with non-US affiliates operates outside of the USA under the brand name of Renaissance Capital.

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Contents

Investment stance

3

Fears of an economic slowdown

6

Capital cycle favours rising returns

12

Management remains focused on value-creation

15

Comfortable balance sheets and supportive dividend potential 18

Value relative to other stocks

20

Positive earnings momentum

22

Commodity price revisions

23

Preference for base metals over steelmaking materials

25

Our long-term commodity prices should not incentivise over-

supply

46

Earnings revisions

47

Risks and catalysts

49

Peer comp charts

51

Commodity price and exchange rate forecasts

52

Important publications

54

Company profiles

55

African Rainbow Minerals

55

Alrosa

56

Anglo American

57

Assore

58

BHP

59

Exxaro

60

Fortescue

61

Glencore

62

Kumba Iron Ore

63

Norilsk Nickel

64

Rio Tinto

65

South32

66

Vale

67

AngloGold

68

Gold Fields

69

Harmony

70

Polymetal

71

Polyus

72

Anglo American Platinum

73

Impala

74

Lonmin

75

Northam

76

Royal Bafokeng Platinum

77

Sibanye

78

Merafe Resources

79

ArcelorMittal SA

80

Evraz

81

MMK

82

NLMK

83

Severstal

84

Disclosures appendix

85

Renaissance Capital

14 January 2019

Metals & Mining

2

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Investment stance

Renaissance Capital

14 January 2019

Metals & Mining

Neutral investment stance on diversified miners

We have a neutral outlook on the metals & mining sector following strong share-price recoveries since 2016’s lows. We believe a cyclical slowdown in commodity demand could weigh on near-term prices.

We believe a potential pullback in metals & mining company share prices could present a medium-term buying opportunity, given our view that sector capex has been cut to a level that could result in supply deficits over the medium term. This could support rising commodity prices and sector returns. We believe management teams continue to focus on value-creation through productivity, cost-containment and capital efficiency rather than volume growth, which is often value-destructive.

Many miners are highly FCF-generative, despite our view that commodity prices are only around mid-cycle levels and supported by industry costs. We believe most commodity prices have not yet recovered to a level that would incentivise greenfield projects.

Given that share prices are still below 2008 levels, despite strong FCF, we calculate attractive FCF yields for many miners.

Attractive FCF yields

We calculate that the sector generated higher FCF yields over the past three years than anything achieved in the previous decade. Spot FCF is still at attractive levels, in our view, compared with the previous decade.

Figure 1: Market cap-weighted FCF yield*, % per calendar year ($ terms)

Ashare-price pullback could present a medium-term buying opportunity

15%

 

 

 

 

 

 

 

 

 

 

 

 

13%

 

13%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

11%

10%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

6%

 

 

 

 

 

 

 

 

 

7%

 

 

 

 

 

 

 

 

 

 

 

5%

 

 

 

 

 

 

9%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

5%

 

 

3%

 

3%

 

 

3%

 

 

 

7%

Average, 2003-2017, 3.1%

 

 

 

 

 

 

 

 

 

0%

 

2%

 

 

 

1%

 

 

 

1%

 

 

 

 

 

 

0%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

-5%

 

 

 

 

 

 

 

 

-4%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

-10%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

-10%

 

 

 

 

 

 

 

 

 

 

 

 

-15%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018E

Spot

Note: Priced at market close on 7 January 2019.

*FCF yield is determined using equity shareholders' cash flow.

Source: Company data, Thomson Reuters Datastream, Renaissance Capital estimates

Following several years of strong cash generation, we think most balance sheets are now comfortable. We believe the sector-wide adoption of payout-ratio-based dividend policies, rather than ‘progressive dividends’, is likely to result in better capital allocation and attractive dividend yields.

We believe continued capital discipline, deleveraging and attractive dividend-paying potential could support share prices.

Attractive dividend yields likely now that balance sheets are comfortable

3

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Earnings momentum remains positive and we calculate further upside risk to consensus earnings forecasts if spot commodity prices prevail. The biggest risks we see are a cyclical downturn in commodity prices and poor capital allocation. The key upside risks to our cashflow forecasts and valuations are stronger-than-forecast commodity prices or weaker-than- forecast producer currencies.

Renaissance Capital

14 January 2019

Metals & Mining

Positive earnings momentum

Cautious on PGM sector following margin recovery

Earnings momentum remains positive for platinum group metals (PGM) miners as commodity prices have recovered strongly. However, we see potential downside risk, as we calculate the spot PGM basket price is trading above cost support for the first time in seven years, making it more vulnerable to escalating fears of a global slowdown. Despite the recovery in sector margins, we still struggle to calculate much value in the sector and believe poor capital allocation risk could be increasing, given improving returns, healthy balance sheets, the sector’s lack of commitment towards dividends and the industry’s historical willingness to invest at value-destructive returns in the hope that PGM prices recover strongly in the medium-to-long term.

Positive earnings momentum could wane in a global economic slowdown

Preference for high-margin, capital-efficient gold miners

We maintain our preference for the Russian gold miners over their SA peers as we believe they are better positioned to create long-term value, with a track record of valueaccretive growth through prudent capital allocation and a commitment to returning cash flows to shareholders. SA gold miners, in our view, are hampered by their uncompetitive costs and capital inefficiency, which result in lower returns and increase the risk of valuedestruction if they try to maintain or grow production volumes. However, over the near term, we believe increasing geopolitical uncertainty and escalating fears of a global slowdown could continue to increase investment demand for gold as a safe-haven asset, providing some support for the price. In a rising gold price environment, we believe the more operationally and financially geared SA-listed gold miners could outperform on positive earnings momentum.

Russian gold miners better positioned to create long-term growth relative to their South African peers

Steel companies offer attractive FCF yields

Our steel price forecasts are derived from input costs plus normalised margins, which results in what we view as attractive operating profits for the Russian steel companies under our coverage. We believe depressed capex levels – below historical averages – aid near-term cash generation. We calculate FY18-21E FCF yields of 9%, on average, for the steel producers. We believe the steel companies’ balance sheets are comfortable, with average FY19E net debt/EBITDA of 0.6x. We think the combination of supportive FCF generation and comfortable balance sheets could translate into supportive near-term dividends in FY19-21E; we forecast average dividend yields of 10%.

Key downside risks to our investment stance are: 1) US sanctions against Russian steel makers or the impact of sanctions on the Russian economy; 2) steel import duties and tariffs in export markets against Russian steel makers; 3) reduced cash generation, weighed down by company project investment activities and by potential governmentimposed investment projects; and 4) earnings momentum has turned negative for the steel producers we cover, which we believe could weigh on share-price performance. We calculate 28% downside to consensus 12M forward earnings using spot commodity prices and currencies.

We forecast average dividend yields of 10%

4

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Renaissance Capital

14 January 2019

Metals & Mining

Revisions to our forecasts, TPs and ratings

Our commodity price and currency revisions, as detailed on pages 24-25, resulted in earnings revisions, as detailed on pages 49-50.

We reduce our TP for Anglo American by 6% to ZAR320 as we incorporate lower base metal price forecasts and increase our capex forecasts closer to management’s guidance during the December 2018 investor day. We downgrade our rating on Anglo American to HOLD (from Buy) following its share-price recovery, given a rising capex profile and due to our near-term commodity demand concerns.

We downgrade Anglo American to HOLD

We reduce our TP for Glencore by 8% to ZAR55 due to lower base metals price forecasts

Glencore TP reduces 8%

and as we increase our equity risk premium from 6% to 6.4% to reflect: 1) the riskier

 

countries in which Glencore operates; and 2) uncertainties around a potential corruption

 

and/or money-laundering investigation by the US Department of Justice.

 

We reduce our TP for Exxaro by 6% to ZAR150 as we reduce our long-term coal margin

Exxaro TP reduces 6%

forecasts somewhat.

 

We reduce our TPs for Assore (by 6% to ZAR300) and BHP (by 3% to ZAR300) as we

 

incorporate lower price forecasts for steelmaking materials.

 

We increase our TP for Alrosa by 3% to RUB109 as we incorporate slightly weaker rouble

 

forecasts.

 

Companies ranked by total potential one-year return

Figure 2 shows the companies under our coverage ranked by potential 12-month returns, based on our TPs.

Figure 2: Summary sector ratings and TPs (ranked by total potential 12M return, including estimated dividends)

Company

Unit

12M TP

Previous

Current

12M target

12M fwd

Total 12M

12M forward

Rating

12M TP

price*

capital return

dividend yield

return

rolling P/E

 

 

 

 

Evraz

GBp

620.0

620.0

475.4

30.4%

15.0%

45.4%

5.9x

BUY

Norilsk

$

24.0

24.0

19.5

23.1%

10.9%

33.9%

9.3x

BUY

Severstal

$

17.1

17.1

14.3

19.6%

11.8%

31.4%

8.1x

BUY

Merafe

ZAR

1.6

1.6

1.4

14.3%

14.0%

28.3%

6.2x

BUY

NLMK

$

26.4

26.4

22.9

15.5%

12.3%

27.9%

8.8x

BUY

Fortescue

AUD

5.4

5.4

4.5

19.2%

7.0%

26.2%

9.2x

BUY

Rio Tinto

GBP

46.0

46.0

38.3

20.1%

5.6%

25.7%

10.7x

BUY

Polyus

RUB

6,300.0

6,300.0

5,286.5

19.2%

6.4%

25.5%

6.5x

BUY

Exxaro

ZAR

150.0

160.0

133.9

12.1%

10.0%

22.0%

6.0x

BUY

MMK

$

9.6

9.6

8.4

14.7%

7.2%

21.9%

11.2x

BUY

ARM

ZAR

150.0

150.0

135.8

10.4%

10.1%

20.5%

6.0x

BUY

Alrosa

RUB

109.0

106.0

101.6

7.3%

12.8%

20.1%

6.7x

BUY

Impala Platinum

ZAR

45.0

45.0

37.5

19.9%

0.0%

19.9%

7.9x

BUY

Vale

$

15.5

15.5

13.8

12.1%

7.5%

19.5%

9.4x

BUY

South32

ZAR

37.0

37.0

33.2

11.5%

6.9%

18.4%

11.1x

HOLD

Glencore

ZAR

55.0

60.0

50.7

8.4%

8.5%

16.9%

9.4x

HOLD

Assore

ZAR

300.0

320.0

294.3

1.9%

8.4%

10.3%

6.8x

HOLD

BHP

ZAR

300.0

310.0

297.0

1.0%

8.8%

9.8%

12.9x

HOLD

ArcelorMittal SA

ZAR

4.2

4.2

3.8

9.4%

0.0%

9.4%

24.9x

HOLD

Anglo American

ZAR

320.0

340.0

311.6

2.7%

5.9%

8.6%

8.7x

HOLD

Polymetal

GBP

8.6

8.6

8.7

-0.7%

6.7%

5.9%

7.4x

HOLD

Sibanye-Stillwater

ZAR

11.1

11.1

10.6

4.9%

0.1%

5.0%

5.3x

HOLD

Anglo American Platinum

ZAR

540.0

540.0

549.3

-1.7%

2.2%

0.5%

13.6x

HOLD

Northam

ZAR

40.0

40.0

42.6

-6.1%

0.0%

-6.1%

11.9x

SELL

Kumba Iron Ore

ZAR

220.0

220.0

274.5

-19.9%

9.0%

-10.9%

11.2x

SELL

RBPlats

ZAR

25.0

25.0

28.2

-11.3%

0.0%

-11.3%

8.0x

SELL

Gold Fields

ZAR

43.0

43.0

50.7

-15.1%

3.5%

-11.6%

8.9x

SELL

Harmony

ZAR

21.0

21.0

27.1

-22.4%

3.5%

-18.9%

4.2x

SELL

Lonmin

ZAR

7.0

7.0

9.1

-23.3%

0.0%

-23.3%

1.6x

SELL

AngloGold

ZAR

110.0

110.0

181.0

-39.2%

1.2%

-38.0%

8.1x

SELL

Note: Priced at market close on 7 January 2019.

Source: Thomson Reuters Datastream, Renaissance Capital estimates

5