Metals & Mining

�� Where To From Here?

With the US metals & mining stocks down 30%-40% in the past 2 months and with investor sentiment decidedly pessimistic, we think it's a good time to revisit the US metals & mining sector. In this note we 'stress-test' valuations, deriving implied valuations based on pricing assumptions that we believe would induce a supply-side response...i.e. marginal cost. Bottom Line: Even in a worst-case scenario, we believe the stocks are already discounting underlying prices that in most cases are below global marginal costs. 5 catalysts for a recovery in the shares -The primary concern we hear from investors lately is "a lack of a catalyst". Often times the catalyst is unexpected and isn't identifiable until after it occurs, but we offer the following five industry-specific events we believe would serve to prompt a recovery in the shares - 1. A near-term rebound in consumption, following the typical summer demand slowdown that has fed into the negative sentiment during the past two months. 2. Recognition and/or continuation of the positive supply-side developments that have accelerated recently…examples in the past 2 months include Chinese export tax hikes, aluminum, nickel, and zinc production cuts, copper supply shortfalls, acute coal shortages in numerous key supply sources (Indonesia, China), Chinese electricity price hikes, etc. 3. Price stabilization - Given the sharp decline in the equities, we believe underlying metal prices simply need to stabilize for investors to re-evaluate their current bearish stance, given most of the stocks are trading at 2.0x-5.0x EBITDA on current prices, implying no conviction in sustainability of current prices. 4. Earlier than expected supply response - Even in the scenario where prices drop sharply, we believe meaningful production cuts will occur quickly (this has already happened in aluminum, nickel and zinc in the past month). The composition of the global cost curve suggests to us similar earlier than expected production cuts in steel and coal at prices that are above levels implied by the equities currently. 5. Acceleration in M&A activity...whether its coal, steel, or base metals, in our view the main change from a strategic buyers perspective vs. 2 months ago is the targets just got 30%-40% cheaper.