Case study: Our thinking on Anglo American and copper supply constraints - Angles & Perspectives Q2 2024

Case study:

Our thinking on Anglo American and copper supply constraints

As investors in Anglo American (Anglo), we were not surprised by BHP’s bid to acquire the company’s copper and iron ore assets earlier this year.

We had assessed the quality of Anglo’s copper assets and concluded that the depressed share price (especially towards the end of last year) offered a very attractive way to gain exposure to tier one copper assets.

Our bullish copper market thesis is predicated on supply
The last copper market cycle was driven by Chinese demand and, while we foresee a medium-term underpin to demand, our views are based on constraints that limit the capacity to bring new supply to market. 

Robust demand growth story
Copper, which has key traditional uses in the power and construction industries, is at the heart of the energy transition and will be required to facilitate the transition to lower-carbon energy.

While shortages are already expected by 2030, the demand for copper is expected to double from
25 million tonnes per annum (mtpa) in 2020 to 50 mtpa by 2050. The additional copper demand over the coming years would come from critical decarbonisation technologies, such as wind turbines, photovoltaic panels, heat pumps, electric vehicles and energy-efficient equipment. While these projections may be dialled down and technological breakthroughs may narrow the deficits, one thing is clear: the world looks likely to be chronically short of copper in years to come.

Constrained copper supply will be unable to match growing demand in time

• Concentrated supply sources. Compared to other metals, copper supply is concentrated with over 40% of production coming from two South American countries, Chile and Peru. This tends to exacerbate supply side shocks. Looking ahead, this level of concentration is unlikely to change, as Chile and Peru have the largest untapped copper resources.
• The copper market depends on a few very old mines to meet the world’s demand. 50% of primary copper supply comes from just 25 copper mines (out of the more than 700 mines that are reported to be in operation today). The average discovery year of these 25 mines is 1928.
• Declining grades a structural feature of the market. In 2010, the top 15 miners’ average grades were roughly 1.2% kg per tonne, while today they are roughly 0.7% kg per tonne.
• New copper discoveries are mainly in ‘higher-risk’ geographies. The superior locations in more investor-friendly geographies are depleted. Today, miners need to look into higher elevations, water scarce areas and more hostile geographies for larger deposits. Two-thirds of new copper resources established in 2023 came from Africa, dominated by the Democratic Republic of Congo (DRC).
• A challenging regulatory environment limits the miners’ ability to build new mines. Regulators have become quite active, in many cases discouraging or delaying approval for major mining projects. The road from copper discovery to production is long and complex – on average, it takes almost 20 years to bring a copper mine into production from the date of discovery. This is a significant impediment to the copper market’s ability to meet anticipated demand towards the end of the decade.
• Fewer new copper discoveries could also lead to an enduring structural supply deficit of copper. The chart below shows how few new copper discoveries have been made in recent times. Of the new discoveries since 1990, only 5% were made in the decade to 2021, in contrast to the 36% in the decade before. This is not because companies are reducing exploration spend but due to them shifting more of their exploration budgets towards known deposits and existing mines. In a world where the red tape to open new mines is so onerous, expanding known deposits is favoured over spending money on discovering new greenfield deposits.

Why we favour investment in Anglo
After not owning Anglo for a number of years, the stock came onto our buy lists last year after it had retreated almost 40% from the highs reached during the supply disruptions associated with the Russia-Ukraine war.

The reasons for investing in Anglo in 2023 still hold:

• We favour investment in copper as a critical metal and Anglo provides a cheap entry point for copper exposure (alongside our longstanding Glencore position). Based on our analysis, pure-play copper names trade at a premium of more than 40% to Anglo (on an EV/EBITDA basis). Furthermore, Anglo has high-quality assets in Peru and Chile and is one of the very few producers that are expected to materially grow production over the next few years.
• Anglo has differentiated commodity exposure to the other majors: PGMs and diamonds are later cycle and have been in a cyclical downturn.
• We also view some of Anglo’s other key assets favourably, including high-quality iron ore and metallurgical (met) coal deposits. Both are highly cash-generative assets whose values are not adequately captured in the Anglo share price.

The share price tumbled by more than 20% in December 2023, after unforeseen production cuts and further cyclical weakness in PGMs and diamonds. We increased our position size, arguing that many of the issues affecting the share price were temporary and cyclical, and that the copper assets acted as the anchor tenant of our thesis.

Unpacking the BHP offer
In April 2024, BHP made an all-share offer for Anglo. The structure of the deal proposed by BHP sent a clear signal that its primary focus was on the copper assets and their growth profile. They proposed excluding the two SA subsidiaries, Kumba Iron Ore and Anglo American Platinum (Amplats), which would be spun out to shareholders. Anglo countered with a strategic plan of their own and eventually, after the Anglo board rejected a revised offer, BHP decided to walk away.

Although we trimmed our exposure at higher levels, we continue to believe that Anglo offers an attractive risk-reward skew for our clients. We argue that the BHP offer vindicates our view that tier one copper assets are scarce and can be acquired cheaply through Anglo. Previously underappreciated copper assets are now in play, and we don’t expect this to be the last copper merger and acquisition. We would not be surprised if we saw another bid for Anglo from BHP (or another major) in due course, if the share price does not rise to reflect the value of these assets.

When we trimmed Anglo in our local portfolios earlier this year after the bid, we switched some of our position into Amplats, which came under pressure given the impending overhang in its shares after the proposed unbundling. Anglo’s iron ore assets also provide a competitive edge given their disproportionate skew to higher-quality iron ore, which is valuable in a decarbonising world. Furthermore, export volumes at Kumba are depressed and should recover with improving SA logistics performance after reforms at Transnet.

One possible catalyst for an Anglo rerating could be a reduction in the risk premium attached to its SA assets. This is much more likely after the market-friendly conclusion of the recent local elections. BHP was not interested in holding onto the SA assets and Anglo is also proposing unbundling Amplats. A change in sentiment towards SA could have a material impact on the Anglo share price. This would mitigate the execution risks and complexity introduced by the strategic plan set forth by Anglo to divest Amplats, met coal and possibly diamonds.

The BHP bid has demonstrated the quality of the assets in Anglo’s portfolio. These factors and the very cheap share price compensate our clients for our concerns about the capital allocation track record of the management team. This company has a history of selling low and buying high, and time will tell whether the mooted exits from PGMs, met coal and possibly diamonds will take place at a low point in the cycle.

The months ahead are unlikely to be boring for Anglo shareholders. However, Anglo has highly sought-after copper assets that are the crown jewel of the portfolio. We don’t think that the current share price captures the value inherent in its portfolio of assets.