Earnings upgrades & strong cash returns ahead? Buy RIO, GLEN, FM

15 January 2018Metals & MiningEuropean Metals & MiningMetals & MiningMetals & MiningRecommendationChangeEuropeNorth AmericaIndustryEuropean Metals &MiningDate15 January 2018Deutsche BankMarkets ResearchEarnings upgrades & strong cashreturns ahead? Buy RIO, GLEN, FMRaising price forecasts and earnings estimatesSince early December commodity prices have rebounded strongly driven bystrong global GDP growth, tight supply and seasonal factors. Consequently, we liftour Q417 and 2018 price estimates (Fig 10) with the biggest near term upgradesto coal and oil. Resultantly, our 2017-18 EBITDA estimates lift by ~10-15% acrossour coverage (Fig 11). For the large caps we sit on average >10% above 2018consensus EBITDA. We expect bulk prices to fade back from Q2 but this is pricedin. Structurally, we continue to see upside (vs spot levels) for copper and nickelover the next 1-3 years.Top picks: RIO, GLEN, FM; Cut BOL to Sell; capital discipline into focusDespite recent outperformance, we maintain our positive sector outlook , asoutlined in our 2018 Mining Outlook. Ongoing capital discipline can re-rate themajors further (10-15% upside to DB mid-cycle) and we expect managementteams to broadly maintain a conservative bias, focusing on selective growth torebuild track records and investor faith in returns. However, we downgrade BOLgiven earnings pressure and expensive valuation. Top picks: RIO (leading cashreturns), GLEN (undervalued growth, base metal exposure) and FM (superiormedium-term copper growth). Sells: ANTO, BOL, S32.Market leading cash returns, but watch for capex, opex, M&A risksWe expect two years of deleveraging to lead to a significant lift in cash returns in2018. RIO remains a leader on this front with a cash return (dividend + buyback)yield of over 8%. By mid 2018 the other majors will be at or below lower thresholdnet debt targets providing scope for great capital management. However, we seeremain wary of capex and opex inflation, while renewed M&A is still a possibletail risk.Valuation check point - DB mid-cycle analysisWe have refreshed our mid-cycle returns and cash flow analysis to provideinvestors with a clear framework of 'what's priced in'. The ~20% move up inthe sector since early December means valuations are approaching fair valuebut remain below our mid-cycle targets (10-15% upside potential). Our mid-cycleFCF model based on long-term prices and normalised capex shows FCF yields of8-11% are achievable for RIO and GLEN. We value the miners on a combination ofNPV and mid-cycle returns & cash flow. Risks: Zinc, copper, TC prices, macro, FX.Liam FitzpatrickResearch Analyst+44-207-541-3233Patrick JonesResearch Analyst+44-20-754-53400Bastian SynagowitzResearch Analyst+41-44-227-3377Patrick Mann, CFAResearch Analyst+27-11-775-7282Robin DraegerResearch Associate+44-20-754-13352Key ChangesCompanyTarget PriceRatingNHY.OL52.00 to 58.00-FM.TO20.00 to 23.00-KAZ.L750.00 to950.00-ANTO.L800.00 to900.00-S32.L170.00 to180.00-BOL.ST250.00 to260.00Hold to SellRIO.L4,500.00 to4,600.00-BLT.L1,650.00 to1,900.00-GLEN.L430.00 to450.00-AAL.L1,400.00 to1,550.00-Source: Deutsche BankDeutsche Bank AG/LondonDeutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should beaware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should considerthis report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONSARE LOCATED IN APPENDIX 1. MCI (P) 083/04/2017.Distributed on: 15/01/2018 05:06:15 GMT7T2se3r0Ot6kwoPa 15 January 2018Metals & MiningEuropean Metals & MiningThe sector in a page...Figure 1: 2018 dividend yields and buybacks (base case)Figure 2: Large cap 2018E EV/EBITDA0.0%1.0%2.0%3.0%4.0%5.0%6.0%7.0%8.0%9.0%RIOBHPAALGLENMarket average dividend yield 3.4%Dividend yield (Dbe)Buyback as % of Mcap0x1x2x3x4x5x6x7xRIOGLENBHPAAL(long term average range)DbeSpotSource: Deutsche Bank, Calendarized data for BHPSource: Deutsche Bank, Calendarized data for BHPFigure 3: Large cap EBITDA - upgrade risk remainsFigure 4: Large cap cash returns (dividends + buybacks)010,00020,00030,00040,00050,00060,00070,00080,00090,0002013201420152016201720182018 at spot(USD mn)0%20%40%60%80%100%120%140%05,00010,00015,00020,00025,0002013201420152016201720182018 at spot(USD mn)Cash returns (LHS)Cash returns as % of capex (RHS)Source: Deutsche Bank, Company data, Factset, Calendarized data for BHPSource: Deutsche Bank, Company data, Calendarized data for BHPFigure 5: Market implied ROCE vs DB mid-cycleFigure 6: Mid-cycle FCF yields (lower prices and highercapex vs 2018)26%21%18%14%27%23%15%15%0%5%10%15%20%25%30%RIOBHPAALGLENMarket implied ROCEDB mid-cycle ROCE0.0%2.0%4.0%6.0%8.0%10.0%12.0%RIOGLENBHPAALStable volumes capexcapex to grow at 2% paSource: Deutsche Bank, FY data for BHPSource: Deutsche Bank, FY data for BHPPage 2Deutsche Bank AG/London 15 January 2018Me