Natural Resource Companies Focus on Returns in 2018
JAN VAN ECK: Hello. My name is Jan van Eck, I’m CEO of VanEck. I’m here today with Shawn Reynolds who is the Portfolio Manager of our Global Hard Assets Fund. Shawn, welcome, it’s exciting to talk about commodities in 2018.
SHAWN REYNOLDS: Thanks.
VAN ECK: We as a firm thought that commodities were bottoming at the beginning of 2016. We’re several years into this cycle now. Tell us what’s happened, what’s happening now, and what you see happening for the rest of 2018?
REYNOLDS: That cycle turn that we saw in the beginning of 2016 was really the result of multiple years of restructuring that went on throughout the entire resource space. That restructuring was really defined by restriction in capex. Part of that was due to the restriction in cash flow because we had lower commodity prices, but it was really an overt effort to restrain capex, focus on operational efficiencies, and really try to get yourself in better shape operationally, as well as financially. We saw some corrections and some strengthening in the balance sheets. As we entered into 2016 we started to see a really good response with regards to better operating performance and better financial performance. Now what you’re seeing (in ’16, ’17, and early-’18) is the beginning of the supply response of those commodities from the outcome of that lower capex.
Looking forward, you really have one of the best setups that I think we’ve seen since the mid-2000s. You have finally a tailwind in the macro sense with regards to better GDP outlook, the first tailwind we’ve had since the financial crisis in 2008/2009. You have the space very much under-owned due to some of the issues that we had in the pre-2016 period. But, more importantly, the industries and the companies are in great shape.
VAN ECK: So the companies are lean and mean. But not all sectors are going through the same thing at the same time, right? So let’s talk about precious metals, base metals, and energy.
REYNOLDS: That’s exactly the way to set it up, starting from 2013, when this restructuring really started. The precious metals (the gold) companies really were the ones that took after it and were, surprisingly, the most aggressive. They got their costs down and continued to push their costs down. That has led, for the first time in a generation, to free cash flow generation. That has been the catalyst for a rerating of those stocks. We’ve seen that happen. They continue to focus on cost. In fact, the early reflections from the fourth quarter results coming out right now are that costs continue to be squeezed. They are looking at some growth opportunities, but very prudently. Most of these companies have big scars on their backs from trying to grow too fast or not focusing on returns with regards to growth projects. The gold industry, in particular, has been bad at that. But they’ve now learned their lessons and are being much more cautious about moving forward. With regards to the more diversified miners, they are.
VAN ECK: These are basically base metals, right?
REYNOLDS: … [b]ase metals, but, like the Glencores and the Rios and the BHPs of the world, that look at lots of different metals. Certainly Glencore was the one that laid the blueprint out there for everybody: How we approach this. We’re going to be very, very focused on only producing profitable ounces and tons. We’re going to focus on returns, focus on cost, and eventually get towards paying a dividend. Maybe paying a special dividend, buying back shares. Now that sector is just starting to inflect to where gold is. They need to start thinking about growth.
VAN ECK: For energy, let’s follow up on that. You talk about the business model of shale companies. Shale is a new phenomenon, so the investors in the industry are still trying to figure out their operating structure, right? Where are they in that process and where do you think the successful ones will end up?
REYNOLDS: I think it’s really important to put where we are in context of an industry that is a 20-year-long industry. We have spent 10 years in shale investing. We grabbed the resource: that was the acreage grab. We invested early on in the infrastructure: pipelines and tanks. We drilled inefficiently early on because we had to assess and frame where the resource base is. All that’s done, as an investment phase, relatively inefficiently. Now we’re inflecting into the harvest mode. You put 10 years of investment in, now we’ve got at least 10 years of harvest to come. The interesting part about that is, you get a steady growth rate with a lot of visibility. But importantly, and this is what I think the market really wants to see, you start to see returns really ratchet up in that timeframe.
VAN ECK: Got it! How will those firms balance returns to shareholders, positive cash flow, dividends, and growth and capex for growth?
REYNOLDS: That is yet to be seen. But I think there’s a lot of pressure from the market these days to be very prudent about how that is used. In the past, really in any of these industries, they would take any cash that they had and they’d reinvest it in the business, sometimes very inefficiently. They weren’t the best capital allocators in the world. There’s a lot more focus on that today. You’ve seen both mining sectors return some of that cash in terms of better dividends, share repurchases, and sometimes special dividends. You’re starting to see the energy space do that. There’s been a couple of companies out there have done share repurchases. They’ve been rewarded. There’s been a lot of companies who are … Well, not a lot. There’s a handful of companies who are saying, “Listen, in 2019/2020 we are on this free cash flow-generating path and we will return that to shareholders.” Those companies who are furthest along on that, they have actually performed quite well, even in a market such as 2017 where energy did not fare so well.
VAN ECK: So, still a little wait and see because the market’s skeptical about the story.
REYNOLDS: Which is fair enough.
VAN ECK: But some of the companies have laid out the path that they need to execute against. It’ll be exciting to see how 2018 develops here. Thanks, Shawn.
REYNOLDS: Thank you.