August 16, 2020

Copper – Setting Up To Soar

I can’t help but share a few of the key conclusions from two big recent copper outlook reports. One, from the Bank of Montreal, assessed the state of supply and demand. The other, from CitiBank, looked at 18 major copper miners in terms of free cash flow and what they might do with their money.

The reports agreed on the big picture: the copper market is heading towards a serious deficit. This is a market that churns through some 21 million tonnes of metal annually…and from 2025 to 2030 it will be short 5 million tonnes of copper annually.

Five million tonnes! That’s 10 billion pounds and a quarter of the entire market. It is a staggering deficit and one that will require immense buildout to meet.

Enter the Citi report. One conclusion: assuming the need for a 15% internal rate of return (after accounting for country risk), Citi sees the need for copper prices of at least US$3.60 per lb. to incentivize the greenfield development necessary to close the supply gap.

OK, so there is strong fundamental support for copper prices to continue rising. On the flip side, prices are already up 24% in a year or 55% in two years. And with stronger prices following years of cost cutting, copper miners are making good cash right now.

Citi’s deck of 18 major copper miners is expected to generate US$125 billion in free cash flow from 2018 to 2022. That’s a lot of money – and it comes against low market valuations. The standout in the group, for example, is MMG, which is expected to generate 115% of its current market cap in free cash flow within a few years.

OK, so they’ll be rolling in cash. The obvious question is: what will they do with it all? There are four categories:

Organic growth: ideal, but while most companies have major projects in the pipeline few of those projects are actually shovel-ready, so opportunities for organic growth are limited.
M&A: will happen, but deals face two obstacles at the moment. First, valuations are reasonable, with most stocks already counting in a long-term copper price of US$3 per lb. and acquirers have to pay a premium. That means the spot price probably has to get above $3.50 per lb. before deal prices will make sense to the market. Second, miners are very wary of political risk, so operations in risky jurisdictions nullify a lot of potential deals. Freeport, for instance, has attractive assets in Latin America but no one wants to take on the risk of Grasberg in Indonesia.
Strengthening balance sheets: some money will go this way, though copper miners’ balance sheets are generally in good shape, with 16 of the 18 companies Citi tracks carry a net debt-to-EBITDA below 1.5.

Shareholder returns: dividends increases are likely, but companies will generally spend to ensure production first.

Lots of money means lots of potential. Sure, Citi sees limited deals among its deck of miners, but that just means those miners will have to look at smaller companies for projects. And there are some available – medium to large copper assets that are largely derisked and will get bought as this cash flow machine really gets going.

The huge supply gap also means strong new discoveries will attract a lot of attention. It isn’t really happening yet – copper discoveries aren’t catching attention like gold discoveries are – but that time is nigh.

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