Market Dynamics and Capital Allocation Drive Metals Outlook
ROLAND MORRIS: Welcome. I’m Roland Morris, the Commodity Strategist for VanEck. We’re here this morning to discuss the industrial metals space with our lead analyst in this space, Charl Malan. Charl, I’m really excited about the industrial metals space. I want to spend some time this morning talking to you about how you see this space, how you see the demand and the supply outlook for the next several years, and where you think there are some exciting stories in the industrial metals space.
CHARL MALAN: Thanks, Roland. Those are some interesting questions you asked me. First of all, let’s focus on the demand side of the equation. As you know, traditionally everybody has been focusing on China, and specifically Chinese demand as it pertains to the base and industrial metals. I think that what is surprising though is that China’s demand has been quite strong. And I think the consensus is that the demand is actually going to be negative. The most recent quarterly data, for the first quarter of this year, is that across the base and industrial metals space demand was 5% - 10% higher on a year-by-year basis.
MORRIS: One thing about China, their economy is transitioning more towards a consumer economy. Is that going to likely be good for the outlook for metals as they continue that transition?
MALAN: Well, it depends upon which metal you talk about. There’s obviously the industrial metals, the iron ore and the steels and things like that that go into the construction portion, that over time will be less beneficial. But your consumer commodities, such as copper and cobalt and aluminum, will obviously have a much longer trend in the sense of consumers consuming, whether it is cell phones or electric vehicles or things such as that.
MORRIS: Tell me in particular about cobalt, which is important for the lithium battery. What is the supply/demand outlook for cobalt?
MALAN: Let’s take the Electric Vehicles Initiative, which is effectively 30 different countries around the world signing up to a certain percentage of electric vehicle penetration rates they want to get to, which is 30% by the year 2030. We see that the demand for cobalt, primarily driven by electric vehicles, will have to increase threefold effectively from about 100,000 tons we produce now, or demand that we have now, to about 300,000/315,000 tons by the year 2030. And that’s a problematic story in the sense that if you look where cobalt gets produced, about 60% of global cobalt currently gets produced in the Democratic Republic of Congo. And if you look at the Congo in itself, which feeds into many, many other metals, it’s got a lot of supply concerns that I am happy to talk about.
MORRIS: As a Commodity Strategist, one of the metals I’m most excited about, because it plays into all those demand stories you mentioned, is copper. One thing I’m curious about is, if we were to get a surprise in demand, whether it was coming from global growth, or just the faster uptake on things like electrical vehicles or alternative energy sources, tell me about the supply side of copper and how quickly the industry could respond to tight markets?
MALAN: First of all, I’ll say that sustaining current global copper supply is going to become a struggle. We’ve seen it for one or two years now. I think over the next number of years, sustaining the current level of supply will be a problem. So, we really don’t want demand to increase substantially, because that’s going to push prices higher. But I think the key thing on the supply side that’s making it difficult to sustain current production is, first of all, grade. Overall the industry is getting older, so we are getting mines where the grades are deteriorating. The second thing that we have spoken about for a number of years is this function of lower capital spending through the industry. The function of capital spending is tomorrow’s supply. And today we’re spending about $20 billion on growing our production base. In 2011, we spent about $80 billion, so there is a massive change in the amount of money that we’re spending. And there’s this whole idea of mining for profitability rather than mining for volume. And I think that’s going to have a big impact on our industry.
But also, going back to the supply side of the equation, the number of new projects that’s coming online has effectively halved over the last four or five years.
MORRIS: I also understand that the developmental time on new projects has become longer over the years and that could also be a hindrance to new supply. Is that correct?
MALAN: Supply is becoming longer, or the time from exploration to production is getting longer, for a whole range of reasons. One of them is just pure economics, economies of scale of these assets are getting lower and lower because the size of the new deposits are just much smaller than what we historically have seen. So, it’s costing us more to produce the same commodity. It takes longer for the decision to be made, because we’re talking about billions and billions of dollars to be spent on bringing a new mine online. The other, newer phenomenon, is just the environmental policies across the world. Environmental policies are becoming a real pinch point for us bringing new production online.
But the real greenfield project that brings 400,000/500,000 tons of copper into the market is just not happening.
MORRIS: Charl, when we think about these companies and how challenged they were when commodity prices were in the trough in late ‘15 and early ’16, and just the change of having modestly higher commodity prices, and what that has done for the operational metrics of these companies, can you just tell us a little bit about their ability to generate cash and return cash to investors?
MALAN: As I said earlier, the big focus now is on profitability versus size. But if you look at the day-to-day operations on a financial level, it is all about “Where do we allocate our capital?” And the structure of capital allocation has been, and it continues to be debt reduction. And, from the big mining companies, you have seen a number of them have reduced their debt over the last two to three years by 60%, 70%, 80%.
You are now going into an industry that, before, was marginally free cash flow, and any cash was used back to pay off debt. It is now generating free cash flow yields of 12%, 13%, 14%, 15%. So that’s why I am saying that the big question, at the moment, is where does this capital allocation go? And what we want to see, and what we are seeing, is that that the capital allocation is still going to debt reduction. It is then going to return capital to shareholders, whether it is dividends, special dividends, or share buybacks. And only as a last alternative are we talking about new projects. We think that in 2017 we started to see the first year of capital returns to shareholders. And if I compare free cash flow relative to capital return to shareholders, I think we could have a multiple in what we saw from 2017 in 2018 and 2019.
MORRIS: Well, this is a very, very exciting story, I think for us at VanEck and for the Hard Assets team, it sounds like we’ve got several years in front of us of some exciting investing to do in the industrial metals space, broadly speaking. Well, I’d like to thank you for listening to Charl and I today. This is a sector that at VanEck we’re very excited about. And the Hard Assets team is looking forward to the future of investing in industrial metals and the exciting stories that we believe are starting to develop, thank you.