Here’s How To Play The Commodity Rally, Says Goldman Sachs

Here’s How To Play The Commodity Rally, Says Goldman Sachs
Carl Hazeley

over 2 years ago2 mins

    • Goldman Sachs thinks the European metals and mining sector is attractive right now, given that it’s set to deliver its highest free cash flow in over a decade.
    • Metals and mining companies are spending less on capital expenditure, have less debt, and are barely increasing their production, setting them up for a windfall as commodity demand rises.
    • The key risks to this opportunity are a lack of capital discipline and a fall in commodity prices.
  • Goldman Sachs thinks the European metals and mining sector is attractive right now, given that it’s set to deliver its highest free cash flow in over a decade.
  • Metals and mining companies are spending less on capital expenditure, have less debt, and are barely increasing their production, setting them up for a windfall as commodity demand rises.
  • The key risks to this opportunity are a lack of capital discipline and a fall in commodity prices.

Mentioned in story

The rally in commodity prices has had everyone’s attention lately, and as analysts at Goldman Sachs recently pointed out, investing in metals and mining (M&M) firms could be a great way to jump on that bandwagon.

💡 What’s the idea?

Compared to the last commodity boom years ago, M&M companies are currently spending less on capital expenditures, and Goldman’s expecting this more disciplined spending approach to continue.

M&M capital expenditure (capex) over time
M&M capital expenditure (capex) over time

Couple that with the firms having less debt than they have done historically, meaning lower interest payments and loan repayments.

M&M net debt to EBITDA (a profit metric) over time
M&M net debt to EBITDA (a profit metric) over time

And even though the stage is set for a surge in demand in metals like copper (of an estimated 600% by 2030), production has been – and is expected to remain – pretty flat.

Copper and iron ore production, historics and forecasts
Copper and iron ore production, historics and forecasts

So supply and demand being as it is, prices of commodities have already started to rise. And whether or not they’ve got further to go, those higher prices should translate into higher earnings and cash flows for miners – the highest in over a decade, in fact. And Goldman thinks that cash is likely to be returned to shareholders by way of dividends and share buybacks.

🚫 What are the risks?

  • Capital discipline: if M&M firms return to high levels of capital expenditure, it’d reduce the cash available for shareholder returns.
  • Leverage: if M&M firms take on more debt, the amount of cash available to shareholders would be reduced by higher interest costs and the likely requirement to keep certain amounts of cash on hand.
  • Commodity prices: a drop in prices – particularly copper – would likely reduce M&M firms’ earnings and FCF.

💰 What’s the opportunity here?

The European M&M industry is expected to deliver $109 billion worth of FCF this year – three times last year’s amount. By Goldman’s calculation, that’s a 10-14% FCF yield. Or put another way, if you owned the entire sector and it paid out all its free cash (as the firm expects most of it will be), you’d receive 10-14% of your investment back in cash before accounting for any share price movements.

The table below sets out the companies in the industry along with key financial metrics and ratios.

European metals and mining comparison
European metals and mining comparison

If you’re in the mood for picking individual stocks, these stand out:

  • ArcelorMittal has one of the highest potential upsides to analysts’ price targets, as well as a relatively high FCF yield from which the company recently committed to pay out at least 50%.
  • Anglo American has decent potential upside to analysts’ price targets versus peers, as well as a high dividend yield as it shifts to a phase of paying out more of its cash.
  • Rio Tinto’s potential upside to analysts’ price targets is limited, but its cash distribution policy is well underway and reflected in its high FCF and dividend yields.
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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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