Falling commodity prices and a mining sector half the value it was two years ago offer opportunities, argues one City expert. Here are his top share picks.
Deutsche Bank’s upgrade on Rio to a “buy” recommendation with a target price of 6,000p comes despite commodity prices falling by more than expected in April and May due to China’s lacklustre Covid recovery and wider signs of industrial weakness.
The City bank points out the Anglo-Australian company has turned a corner operationally, and said the recent 20% decline for Rio shares from their January year-to-date high exposed “attractive value underpinned by a high-quality, cash generative business”.
In its review of the mining and metals sector, Deutsche Bank also continues to have a “buy” recommendation on commodities trader Glencore after highlighting a price target of 560p.
Anglo American (LSE:AAL) is rated at “hold” due to concerns over free cash flow generation and risks associated with the development of the former Sirius Minerals’ Woodsmith fertiliser project.
Deutsche Bank said: “We see value across many names at present, but, given the macro risks, believe a selective approach makes sense in the shorter term.”
The report cuts earnings estimates for 2023 by an average of 10-15%, but sticks to an unchanged profile of a third-quarter trough followed by a 2024 recovery.
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The bank said: “While a sharp US recession or further financial stress are downside risks, we remain of the view that when the cycle turns back up prices should rebound sharply towards incentive levels due to low inventories and inelastic supply.”
The consensus has turned progressively more bearish towards Rio in the past three years due to concerns over the iron ore market and company specific ESG and strategy issues.
Deutsche Bank believes the shares now price in iron ore falling as far as $80/85 a tonne, whereas its own projection stands at $110/$115 in 2023/24 notwithstanding the short-term risk that prices grind lower through the seasonally soft summer months.
The bank’s analysts are 15% ahead of the City consensus for Rio’s earnings and see a 30% return potential over the next 12 months based on the 18% upside for shares and the forecast 2023 dividend of 416 cents a share.
They believe their projection for average annual free cash flow over the next three years of about $9 billion, which compares with the five-year 2018-22 average of $10 billion, should support a through-cycle dividend yield of more than 7%.
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The bank said: “Operationally, we believe Rio has turned a corner, with the relatively new leadership team now delivering more consistent results.
“Following five years of non-existent production growth, Rio offers a medium term pipeline that is superior to peers and not discounted by the market.”
In particular, Deutsche Bank notes that the Pilbara iron ore business is shifting to a stronger position as the ramp up of the Gudai-Darri mine should provide flexibility to expand production to market demand in the years ahead.
The report adds that volumes in the copper business should grow significantly over the next 3-5 years, driven by the development of Mongolia’s Oyu Tolgoi mine as one of the largest known copper and gold deposits in the world.
Deutsche Bank also believes the aluminium division is well positioned to expand margins through low-carbon intensity and power integration.
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