Words of Wisdom on M&A in Mining Sector Mining Sector - 2018 Outlook
Tom Archer • 15th March 2018
Is a ‘resources boom’ around the corner? Healthy balance sheets, high commodity prices and hospitable equity markets have sparked hopes that the sector is about to experience a huge upturn.
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At what point does a recovery become a resurgence?
We’ve seen the mining sector make a steady recovery in the last three years. Companies survived the recent slump by spending cautiously, with the result that they begin 2018 with reduced debt, record dividends and substantial cash reserves.
“Anglo [American] is set to make its first annual dividend since 2015. Rio Tinto … is forecast to make its highest ever full-year dividend and buy back $1.9 billion of stock. Even Glencore, which usually favours deals over dividends, in December promised to double its payout this year. Still, even after those distributions to shareholders, the industry will have $80 billion in excess cash over the next three years, according to Macquarie Group Ltd.” Bloomberg
One might think that the sector’s renewed vigour would have heralded a resumption of spending. But this has not yet occurred. Not wanting to repeat their past mistakes of borrowing and over-investing, the majors have remained reluctant to funnel their cash into new projects.
“Mining companies have spent the past few years retrenching and getting their financial houses in better order, rather than spending on development and exploration.” Brian Milner, Special to the Globe and Mail [ii]
“No one wants any new mines, but you have to use this money for something, and it’s not all going as dividends.” Ben Davis, Analyst at Liberum Capital Markets (via Bloomberg) [iii]
Despite this reluctance by the majors, the sector is still gathering momentum, as investors are comfortable to return to a more disciplined industry.
“The rising number of exploration projects, equity and debt financing, and mergers and acquisitions indicates a renewed confidence in the sector, while an overall more cautious approach to spending cash suggests a more disciplined industry than before the downturn.” PwC: Junior Mine 2017 [iv]
Junior explorers and developers, no longer struggling to raise capital, have been able to finance and advance projects once again and present the majors with viable ways they might responsibly utilise their cash reserves.
“There will be a lot of mergers in the next 12 to 24 months. The market is pretty desperate for new exploration. That will change the strategies of the majors. They are struggling because they have to buy in, do joint ventures and have a look at companies at a way earlier stage.” Tobias Tretter, MD of Zurich-based Commodity Capital AG [v]
Battery metals leading the charge
The area that has gathered the most investor attention in 2016-17 has been battery metals (copper, nickel, lithium, zinc, cobalt), as companies seek to take advantage of high commodity prices and hurry to anticipate the market penetration of electric vehicles (EVs).
[vi]
“The quest for capital is being fuelled in part by a strong recovery in base metals such as copper, zinc, cobalt and lithium. The sales pitch centres on demand for electric vehicles, whose batteries are made with the latter two metals.” Brian Milner, Special to the Globe and Mail [vii]
Cobalt in particular has received the greatest hype. It is a key ingredient in the current design of Lithium-ion batteries (the type used in EVs), but current supply mainly originates in the Democratic Republic of the Congo, a very unstable jurisdiction. This has opened up an opportunity to find diverse sources of Cobalt while global demand remains ahead of supply.
“Because cobalt is a by-product of copper and nickel [mining], these higher prices don’t tend to stimulate new supply like other markets would. And so there isn’t necessarily groups that are going out or majors that are going out and looking to build out their projects based on cobalt alone. […] So this gives an opportunity for the junior market to go out and discover some of these projects and advance some of these cobalt-rich deposits.” Mitchell Smith, President and CEO of Global Energy Metals Corp [viii]
But as ever the usual caveats should be borne in mind. With literally hundreds of battery metal focused juniors vying for assets, not all can be winners.
“With the number of cobalt miner ‘wannabees’ on the ASX approaching 100, not all these bees attracted to the cobalt ‘honey pot’ are equal, and many will fall by the wayside.” Bob Kohut, www.thebull.com.au [ix]
Any future ‘boom’ will be vastly different to previous years
External market trends and the tighter spending habits of the majors have changed the landscape for the entire sector, as outsiders such as car and technology companies are increasingly cutting out the middle men and making supply deals directly with mining companies.
“In 2015, Tesla signed early stage agreements with junior mining companies to supply their new ‘gigafactory’ in Nevada with lithium.” PwC Future of Mining [x]
BMW is seeking to secure their supply of cobalt and lithium for EV batteries: “The aim is to secure the supply all the way down to the level of the mine, for 10 years. The contracts are ready to be signed.” Markus Duesmann, BMW’s head of supply chain [xi]
“Apple Inc. is in talks to buy long-term supplies of cobalt directly from miners for the first time.” Bloomberg [xii]
The appeal of this strategy is clear for EV companies whose audience is environmentally-conscious consumers. But more broadly, the pressure to have a transparent supply chain and to avoid supporting unpopular regimes (e.g. the DRC) could mean that other technology companies follow suit.
“In this future, big brand technology businesses acquire diversified mining portfolios to deliver on a brand promise that the minerals that go into their products are produced in the most responsible way.” PwC Future of Mining [xiii]
Importantly, technology is changing the sector in ways beyond setting new commodity trends. The recent rise of blockchain could revolutionise how commodities and assets are traded, affecting in turn the way mining companies seek to generate value and market interest.
“In this future […] Fintech companies use blockchain technology to create marketable parcels in mineral reserves and mining outputs that are measured in kilograms rather than tons and contracted years in advance of actual production. Mining assets change hands faster than ever imagined. Some precious ore bodies are kept in the ground, never mined but still traded, effectively securitizing reserves.” PwC Future of Mining [xiv]
Our View
Renewed potential in the mining sector could trigger a resurgence in 2018. How will the old guard adapt to the challenge of outsiders entering the sector, who will come out on top, and how can junior companies make the most of the new landscape?
SI Capital believes the sector currently sits in a unique position and we see an opportunity for investors to take advantage of low valuations.