For the first time in three years, Citibank has moved its 12-month sector stance from neutral to bullish.
While the bank said in a report that it “remains concerned about the potential long-term structural demand story for commodities in China, and [is] cognisant of a potential seasonal slowdown in the first quarter of this year,” its shift to a more bullish stance “reflects better bottom-up fundamentals, particularly from the major miners.”
New York-based Citibank said it believes the alpha drivers of valuation, growth, operational efficiencies, capital structures and self help will be the dominant themes playing into the hands of large, diversified miners — of which it favors Rio Tinto (LSE:RIO,ASX:RIO,NYSE:RIO), BHP Billiton (NYSE:BHP,ASX:BHP,LSE:BLT) and Glencore Xstrata (LSE:GLEN) to outperform the sector in 2014.
The bank, however, said it remains underweight on gold and base metals stocks, and named Anglo American (LSE:AAL) as its least favorite large-cap miner. It also placed sell ratings on Antofagasta (LSE:ANTO), First Quantum Minerals (TSX:FM,LSE:FQM), Nyrstar (EBR:NYR), New World Resources (LSE:NWR), African Barrick Gold (LSE:ABG), Fresnillo (LSE:FRES), Hochschild Mining (LSE:HOC), Petropavlovsk (LSE:POG) and Randgold Resources (LSE:RRS).
Further expounding on its bullish stance for mining, Citibank said that even though “investor sentiment has hit rock bottom,” having moved through five stages of denial, anger, bargaining, depression and now acceptance, it believes that the industry’s bottom-up fundamentals have improved.
“Improvements in European and US growth are supportive for commodities and weakening commodity currencies are providing a fillip for the miners. Against this backdrop the mining companies are cutting costs, improving balance sheets and aligning with shareholders, which are resulting in an inflection point in the secular trend of EVA [economic value added] creation,” reads an excerpt from the 36-page report.
The bank forecasts compound annual growth rates (CAGR) in earnings of about 7 percent, with free cash flow yield expected to grow at a CAGR of 23.9 percent until the end of the decade.
While Citibank is putting its faith in diversified miners as the likely standouts in the mining sector, it was not so optimistic about pure-play mining companies, saying they “generally struggle to deploy capital efficiently, either they lack the available opportunities and/or the projects are being forced up the capital structure either through higher operating costs or capex costs.”
Thus, the bank recommended that in the current “steady” commodity price environment, investors should own the most efficient, lowest-cost producers.
Securities Disclosure: I, Andrew Topf, hold no investment interest in any of the companies mentioned.