Unloved, under-owned and seen as a negative in terms of ESG, the Mining sector now finds itself in the spotlight.
With the ongoing push into ESG investing, many fund managers still have long memories about losing money in previous super-cycles and in terms of outlining an investment process, it’s an easy call to exclude miners for previous bad behaviour and perceptions of poor ESG credentials – most active managers are underweight the sector. You can see just how wary investors are of the world’s biggest miners by looking at how markets are valuing the enormous dividend flows from the sector.
The UK’s ‘big 4’ – Anglo American, BHP, Glencore and Rio Tinto are set to record results this year that should comfortably surpass the profits made during the last commodity bull market a decade ago. They all have stronger balance sheets and much reduced M&A and CapX spend. The only route for that cash is back to shareholders via dividends, special dividends and share buy backs. JPMorgan reckons Rio and BHP are likely to pay the largest dividends in corporate Europe this year at almost $20bn and $18.2bn respectively. With dividend cuts from ‘big Oil’ and the banks, the Miners have stepped up to the plate.
While share prices have risen sharply since the pandemic lows in March, so have commodity prices. However, there has been no re-rating as such for the sector, even though it will have a crucial part to play in the shift to clean energy and the post-Covid economic recovery. At current prices the value of BHP, the world’s biggest mining company, including net debt is just 3.5 times its forecast EBITDA (and those forecasts may prove conservative). That is a huge discount to the multiple of just under 10 times for the MSCI Europe companies. And these are great businesses by most subjective standards, with huge barriers to entry, strong market shares, strong cash generative characteristics and operating margins that vary between strong and obscene, none of which is truly reflected in the ratings. The market is still viewing these companies through the rear view mirror rather than the road ahead.
These companies find themselves in the ultimate sweet spot of restricted supply and both cyclical and structural demand growth.
Let’s look at some of the basics:
- Balance sheets have been repaired, M&A effectively red-carded, and the same for ambitious new supply projects.
- Over a decade of under-investment has meant that supply growth has been minimal, which has only served to concentrate market share amid the low-cost mega-producers.
- Each commodity has its own additional specifics, such as the issue of ore degradation and increased overburden costs for Copper and the Iron Ore supply land grab several years ago by RIO and BHP which steepened the industry cost curve and added a further deterrent to new supply.
- As a result, supply is extremely tight for many metals and any industry response is several years away.
On the other side of the equation, we are seeing both a cyclical and a structural boost to demand. There is the obvious post lockdown cyclical upswing, boosted by short-term and medium-term Govt stimuli – Biden’s infrastructure plans being the obvious example. The less obvious and more surprising is the structural shift to clean energy, which will be a huge boost to demand for those unlikely ESG saviours, the big miners.
According to the International Copper Association (ICA), a battery-powered electric vehicle uses 83kg of copper, a hybrid electric vehicle 40kg and an internal combustion engine with only 23kg of copper. When you then factor in the shorter life span of an electric car battery, the implied demand growth for Copper from a global switch to electric vehicles far outstrips the ability of the copper industry to meet that demand. A renewable led electricity supply requires a more robust distribution system, which adds further to the implied supply deficit when faced with the requirements to go carbon neutral. For some of the highly specialist metals, such as Lithium, the demand/supply crunch is even greater.
Given all this it is no surprise to see the likes of Copper and Iron recently hit all-time highs.
And yet the market isn’t buying into this. Mining equities reflect long-term commodity price assumptions, and these have not moved up significantly, not yet anyway.
Some caution on the part of investors is understandable. Mining comes with unique environmental, social and governance risks and some investors, scarred by a turn in the commodity cycle in the past, might question the sustainability of current prices.
Then, as now, commodity markets were tight and the world was recovering from the financial crisis. However, that period marked the top of the cycle. The LME metals index, a gauge of major metals trading in London, subsequently fell 50 per cent over the next five years and the market capitalisation of London’s five largest listed miners plunged 75 per cent. But, (and investors hate this phrase,) “it’s different this time”
When commodity markets tanked post-2011, the cycle was already mature, with China’s rapid industrialisation already well established. This cycle is still in its infancy. The global recovery programmes that governments are putting in place today are more commodity-intensive than was the case after the financial crisis.
As we said earlier, Miners are also much more disciplined and focused on shareholder returns than they were 10 years ago. Even if they wanted to explore M&A or new projects, there just isn’t enough of either to soak up the prodigious cash flows that are coming their way.
Not only is clean energy driving structural demand growth, but the industry is also in a better place from an ESG perspective. Many have, or are exiting thermal coal, safety protocols have continued to improve, and the majority of the industry have signed up to various climate change initiatives. Just to give one example, the industry has visibility for copper and lithium supplies in terms of ESG best practice, but can Apple say the same about their smart phone suppliers?
Recent months have seen spot commodity prices starting to reflect the extremely tight demand/supply conditions and whilst share prices have started to react, they still imply a very cautious view on assumptions for medium to long term prices for these commodities. Meanwhile, for the big industrial mines, the cash keeps flooding in and the shareholders will be the ultimate beneficiaries.
Need to know more? If you have a question, would like more information or are seeking financial planning or Wealth Management advice please contact hello@jarrovian.co.uk
Jennifer Turner
