European Mining: Still set fair into year-end

One month on from upgrading our European Mining industry view to Positive, we round up developments on the macro, commodity and equity-specific fronts.

Macro data has generally been supportive. Earnings momentum continues to underpin equity outperformance, with upgrade pressure concentrated in the bulk commodities and diversified equities, where valuations remain compelling. We mark to market coking and thermal coal and manganese prices, driving earnings and PT upgrades.

Macro ok: An important month, with China seemingly still pursuing a FAI/infrastructureled support policy for the economy albeit with some cooling off of the property markets, both of which we expect to continue. Currencies remain key with concerns unfolding (similar to earlier this year) over CNY but GBP becoming a key driver. US data is not fully consistent with a December rate rise according to our US team.

Bulk commodities in the driving seat: Coking/thermal coal, iron ore and manganese continue to push ahead of consensus expectations and are the principal source of mark-to-market upgrades right now (alumina perking up too). Base and precious metals are both looking up with events. We upgrade our coking coal assumption to $138/t in 2017 (+36%), reflecting the likely slow supply response and potential for weather-related issues in Australia from La Niña. We also mark to market thermal coal and manganese assumptions. As we flagged a month ago, iron ore is being supported by the producers at last coming to the conclusion that by producing less (or even just suggesting that they might) they can make more – this was backed up by last week’s guidance cuts from Vale and Rio. Copper and aluminium both look unexciting for the time being while we are seeing signs of supply response in zinc.

Mark-to-market upside in the equities still robust: There remains a considerable gap between 2017 spot EBITDA vs. consensus (37% for diversifieds), implying earnings upgrades should remain a strong tailwind for the sector. Positive revisions are concentrated in the bulk-exposed equities, with precious metals generally staring down the barrel of material M2M downside.

Valuations/stock specifics: Valuations on spot look particularly cheap for the diversifieds, with single-digit PERs, EV/EBITDAs that start with a 4 and double-digit free cashflow yields, leading to rapidly declining leverage and increasing dividends. Our favoured name among the diversifieds remains South32 (cheapest valuation, best EPS momentum and resulting cash return potential), while among the more liquid names our preference is for Rio Tinto, with AAL and BHPB both EW. The copper producers continue to look expensive. Boliden remains the exception and is our Top Pick in European Mining on zinc exposure, valuation discount and rapid deleveraging. Gold is taking a seasonal pause leaving the equities generally at risk of downgrades, but we would be tempted to add exposure during this pullback – Randgold is our favoured name on yield potential with Q3 results (3 Nov) likely to present a better buying opportunity.

Barclays Equity Research