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Decarbonisation trends lead Deutsche Bank to downgrade BHP and upgrade Rio Tinto

“While some of the trends are long term, they matter for equity valuations today,” analysts said

Coal and decarbonisation
Rio Tinto is no longer in the thermal coal business

As cutting carbon and greenhouse gases gain prominence around the world, Deutsche Bank has downgraded mining giant BHP Group PLC (LON:BHP) but upgraded rival Rio Tinto PLC (LON:RIO). 

“Decarbonisation has emerged as a key challenge facing the materials sectors. While some of the trends are long term, they matter for equity valuations today,” analysts at the bank said in a note to clients on Thursday.

BHP was downgraded to a ‘hold’ recommendation from ‘buy’ based on three key drivers, led by newly revised long-term steel demand projections and lower long-term coking coal price forecasts. 

The Anglo-Aussie miner has the lowest exposure to ‘energy transition’ metals, with around 80% of underlying earnings being from iron ore, coal and petroleum, “and the greatest downside risk under a rapid decarbonisation scenario”. 

With BHP committed to diversifying away from steel raw materials and reinvesting in petroleum and potash, “this makes for a more complicated climate strategy vs. peers” and the shape of its portfolio “could lead to the company pursuing higher risk projects and potentially M&A”. 

Having upgraded the shares in March following their aggressive coronavirus-induced sell-off, the analyst wondered whether “the company's coking coal and petroleum exposure garner a premium in the years ahead as ESG integration spreads and the terminal values of fossil fuel businesses are put under even greater scrutiny?” and in response cut their target price to 1,650p from 1,750p.

Meanwhile, fellow Anglo-Aussie Rio Tinto, which exited the thermal coal business in 2018 and is a low-carbon aluminium producer, was upgraded to ‘buy’ from ‘hold’ with the target upped to 4,900p from 4,600p. 

From their deep dive into the decarbonisation challenges facing the sector, the analysts believe Rio's portfolio “is better positioned for the long term and, in the shorter term, RIO offers compelling near term cash flows and cash returns”. 

Aside from short term seasonal risks, the number-crunchers expect iron ore prices to remain elevated in 2020 and 2021 due to China stimulus and ongoing supply constraints. 

Deutsche also said Woodsmith polyhalite mine and De Beers owner Anglo American PLC (LON:AAL) was a ‘buy’, being another that is “well positioned with relatively high exposure to copper, the most ambitious and integrated climate targets and strategies and strong bottom-up stock drivers”. 

“While each of the majors has a mix of portfolio strengths and weaknesses, Anglo benefits from relatively high exposure to transition metals with a strong pipeline of growth options in copper and PGMs.”

Quick facts: BHP Group PLC

Price: 1697.2 GBX

Market: LSE
Market Cap: £85.83 billion

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