Bloor Street Capital Virtual Copper Conference
May 12, 2023 | (53 mins 10 secs)
Sprott Asset Management’s Shree Kargutkar, CFA, speaks with Bloor Street Capital’s Jimmy Connor at the May 11 Virtual Copper Conference. Shree discussed the supply/demand scenario for the metal and how it may change with the growth of electric vehicles, geopolitical factors impacting global copper mining and recent M&A activity in the sector. He and outlined the potential investment opportunity copper and its miners provide.
James Connor, Bloor Street Capital: Hi, Shree. Thank you very much for joining us today. You are a portfolio manager at Sprott Asset Management, and you and your firm are very bullish on the energy transition movement. This movement will require a lot of different metals, including copper. This is where I want to focus our discussion today. Maybe we can just start with why you are so bullish on copper.
Shree Kargutkar, Sprott: Well, like with most commodities, the reason to be bullish or bearish on a commodity all comes down to one thing, which is the supply-demand balance. As it relates to copper, we have seen the amount of mine supply of copper remained at around the 20, 21 million tons for the past 5 or 6 years; while the amount of lease cycle supply that's been entering the market has been somewhere between 3 and 4 million tons per annum, whereas the demand side of things has continued to pick up.
This year, for example, we likely find ourselves on the razor's edge of supply barely meeting the demand. As we progress through the years, we're likely to see demand for copper grow by around half a million tons per annum conservatively, or it could be even higher. For this reason, it is very easy to be bullish on copper, especially as the demand side of the picture is concerned.
When we look at the supply side, there are not a lot of new mines that are coming onstream. A lot of producers are really struggling to maintain their production. We're going to be looking at a scenario where the world needs more copper, the miners want to mine more copper, except they can't really mine more copper. We're going to have a scenario where supply is just not going to keep up with the demand for copper. For that reason, we're quite bullish on copper.
James Connor: There are a couple of elements there that I want to hone in on, and the first one being demand. A lot of this has to do with this movement toward electrification and also EVs [electric vehicles]. EV sales in 2022 were 10 million versus 6 million the year prior. Of course, this is going to require a lot of copper. Maybe you could just touch on that and the growth in the EV sector and how this is going to impact copper.
Shree Kargutkar: Sure. The amount of growth we have seen in electric vehicles has been quite phenomenal. Last year alone, like I said, around 10 million electric vehicles were sold around the planet. What many people are just now starting to realize is just how much more copper goes into EVs. A typical EV needs somewhere between three and four times the amount of copper versus a traditional gasoline-powered vehicle.
Now, where things get really interesting is that EVs don't just drive themselves. They need electricity to drive themselves. In order to have the infrastructure there so that people can drive their EV from point A to point B, and be able to charge it somewhere in between once or more, you need to have all these charging stations set up. All these charging stations and the associated infrastructure require quite a bit of copper—just to lay it all out and have it be there.
For this reason, the amount of copper that's going to be taken up by this whole electric vehicle movement or really the revolution that's underway is going to catch a lot of people by surprise. It's probably going to catch many countries and some companies even to be a little bit flat-footed.
The same thing can be said about a lot of these electricity producers as well. They just won't be able to keep up with it.
James Connor: You also made a comment earlier about the geopolitical situation and how that will impact the copper supply. The two largest producers of copper are Chile and Peru. Maybe you can touch on how important these two countries are in terms of global production. What's happening there in terms of the geopolitical situation?
Shree Kargutkar: Right now, like I said before, the total mine supply coming out from all the countries around the world is around 20, 21 million tons per annum. Out of that, Chile represents 5.5 million tons per annum, give or take. Then we have another two and a half million tons of supply coming out of Peru.
The number one and number two countries or producers of copper put together are putting out around eight million tons of supply versus about 20 million tons of total global mine supply. It's quite easy to see why these countries are as important as they are for the copper supply chain.
Now, what we have seen recently is a couple of things happen. With Chile, for example, there has been a little bit of interest from the government to try to increase the taxes that the copper industry pays as well as try and lift their royalties. This all was going on over the last couple of years.
Thankfully, the changes that were made for the taxes that the copper producers have to pay were relatively modest. The impact as a result was not that bad. But more recently, the same government out of Chile has tried to make some noise in the lithium space. They want to try to actually nationalize some of the lithium projects that exist in Chile, for example.
Obviously, this rhetoric is something that can cause a lot of investors to feel uneasy and that type of uncertainty, and the unease that exists makes it more likely for producers or developers that are looking to fund their projects to be less likely to put in the big capital outlays that are necessary to build new mines. That's the picture for Chile.
Now, stepping over to Peru in the last few months--an this has been making headlines. There have been plenty of social unrest all across the country. This is linked to the previous president who was removed from office. There have been spontaneous protests that have been emerging out of various different parts of Peru, lots of clashes, lots of violence between the authorities and protesters.
This all has a very negative impact on the mining industry because the protesters have been trying to make it more difficult for goods and equipment to be able to move from point A to point B. The mining sector, especially, has been quite heavily impacted.
James Connor: Then, of course, the results for the situation in Panama with First Quantum?
Shree Kargutkar: Yeah. First Quantum has made a substantial investment in Panama to try to bring Cobalt Panama into production. There was a very long, protracted, and intense negotiation that took place between the government and the company to try to cut the terms as to how the profits that are generated from this mine will be shared between the private corporation and the government.
James Connor: It doesn't matter where you go in the world, the governments are always trying to take more, aren't they?
Shree Kargutkar: It's just name of the game. Anytime there's any material left in the price of any given commodity, if there are one or two outsized areas of profits, the taxman cometh.
James Connor: We talked about how the supply might be disrupted, but let's also talk about the demand side. China is the world's largest consumer of copper at approximately 60%. Now that China is opening up again, what do you think this will do to the copper price of anything?
Shree Kargutkar: China has been reopening itself for the past several months now. What we did see happen is that some of the commodities that China typically has stored in its warehouses that the inventory levels have been drawn down. You could have seen this happen with copper as well.
China has been quite busy restocking. As they, "reopen" and as they try to stimulate their economy to get it to grow the way the government wants it to grow, we'll likely continue to see an increased amount of capital make its way into infrastructure projects and other types of stimulus measures, all of which are going to be quite beneficial for copper.
James Connor: That's a great overview of the supply and demand side of the equation and how that might impact the copper price. Now, I'm curious how you and your team value copper equities. Maybe you can just give us some idea of the analysis that you do on a producer versus a developer.
Shree Kargutkar: It's quite important to just, for us, at least to try to think about companies depending on the life stage or the lifecycle that they're in. As it relates to exploration companies and developers, they don't have any cash flows, obviously. As investors, we are oftentimes trying to figure out how much dilution we have to deal with on the equity side or how much debt these companies will have to take on in order to bring their projects into production.
As a result, oftentimes we will value developers much more onerously or a bit more conservatively, let's put it this way, versus a producer. Producers have existing cash flows or cost profiles that were very well understood. As far as producers go, we are typically using more of analysis trying to figure out what the net asset value of the project is, what type of cash flows can be expected at various copper prices.
We typically have a relatively decent amount of visibility on their cash cost, bringing this copper out of the ground and into a form that is useful for the end user. Producers are typically valued more or less on the basis of the cash flows, on the basis of the NAV.
For exploration companies and developers, we're trying to do a similar level of analysis but with less visibility because we don't really have a great window into what their actual cost will end up being like or when the project will be in production.
James Connor: What copper price do you and your team use to value copper equities?
Shree Kargutkar: The price of any commodity that we use for analysis of any company, really, is more or less close to spot prices, because we typically try not take a view as to which direction the price of the commodity is going to move. We try to look at things as they are today.
The only scenarios where we will use prices that are different from the prevailing prices of a commodity is when we have seen a sharp increase in the commodity where maybe a stronger element of conservatism is oriented; or if you're seeing a sharp decline in the price of a particular commodity, in which case it's okay to be a little bit more optimistic as to where the commodity can go. But generally speaking, we use the prevailing metal prices.
James Connor: How does the current valuation of the copper sector compare to historical valuations? Do you and your team see good value in the sector right now?
Shree Kargutkar: If you look at how the sector—and I'm talking about the copper producers today, and there really aren't that many. If you compare where they trade today in relation to the past 10, 15 years, you'll see that the valuations have more or less remained in a particular range.
If you look at it from an EBITDA perspective, if you look at it on a price-to-cash flow perspective, the valuations that we see today—and I'm talking on a general level—are not completely different from where valuations have been for the past decade or so.
But where we see value is on a name-by-name basis. It will be in a producer, for example, where we can see a significant amount of my life extensions coming, which are perhaps not pricing it. We can see value in certain producers that are perhaps being punished unfairly because of a poor quarter that was put out, and we try and take a longer-term view on things.
I would say there is certainly value to be had in this space, but it really is a function of doing the work and trying to figure out which particular security is the one that should be bought.
James Connor: Shree, you brought up a very good point in that there really isn't a whole lot of copper producers out there. One of the reasons is because we've seen so much M&A in this space. Just in the past year, we saw Rio Tinto come in and buy Turquoise Hill. We also saw BHP earlier this year buy OZ Minerals. Hudbay is currently buying Copper Mountain. Of course, there’ve been numerous overtures for Teck Resources.
What are your thoughts on what's happening with the M&A right now? Do you think this is going to continue?
Shree Kargutkar: I think M&A in pretty much any commodity that you look at is going to take center stage every so often during the commodity cycle. Right now, like I said before, we are staring down a potential supply-demand imbalance with supply just not being able to keep up with the demand. A lot of the copper producers today see that as well. For that reason, they're just out there trying to buy whatever supply that they can for a price that they view as being quite opportune.
Will there be more M&A in the copper space? I would suspect so. There's very little reason to believe why there wouldn't be more M&A. A couple of things that I'm also seeing right now are for producers these days to try and maybe... Depending on the producer in question, but more and more producers these days are trying to focus their M&A in more safer jurisdictions where perhaps the...
Like Hudbay and Copper Mountain, like you just pointed out, where the production is actually coming from countries with a very stable jurisdiction, with a very stable tax code, and where the operating risk from social economic perspective is quite minimal compared to some of the more, I guess, jurisdictions that are still developing their mining industries.
I think that theme will likely play out where producers look to buy existing or future production in countries that are viewed as highly friendly.
James Connor: Shree, I know you and your team also cover lithium producers. We've seen a number of OEMs [original equipment manufacturers] come in and make equity investments into these producers, and we never would have expected this just a couple of years ago. But do you think we might see the same thing in the copper sector where we see an OEM come in and make an investment in a copper producer?
Shree Kargutkar: It's not something that I would rule out. There has certainly been a lot of chatter coming from the OEMs as it relates to lithium, and as it relates to nickel. Those are just the two commodities so far. It would not be surprising if we are in a scenario where copper all of a sudden becomes as tight as lithium is today. It would not surprise me to see OEMs start to become a little bit nervous and perhaps make some investments here and there to make sure that their security of supply is guaranteed.
James Connor: Shree, as we wrap up, where do you see the copper price going for the balance of 2023?
Shree Kargutkar: At Sprott, we don't really forecast the price of any commodity. We don't publish any forecasts. But like I said before, copper is a rather unique metal right here, right now, and the supply of copper is not growing at the rate that it should. But the demand for copper is likely to keep growing and perhaps accelerate as electrification starts to take hold. It's not that difficult to see copper prices needing to be sustainably higher versus where they are today.
The other thing I'll also point out is that the mine grade of copper coming out of the ground continues to decline. Just because copper is becoming more and more difficult to extract, the price of getting this copper out of the ground does not go down. As a result of the rate going down, mine costs go up. We're likely to see higher prices as a necessity in order to guarantee the supply coming out of the ground.
James Connor: That's a very good point. That was a great overview of the copper sector. I want to thank you for sharing your insights with us today. I look forward to our next discussion.
Shree Kargutkar: Thank you for that, Jimmy. Always a pleasure.
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