RTNTF - Antofagasta: Quality Copper Pure Play

Summary

• The supply/demand imbalance in copper has already started.
• I like Antofagasta for fundamental value and macro reasons.
• The copper miner has a clear runway for production growth after years of development capex.

The recent Glencore plc ( OTCPK:GLCNF ) investor update made a strong case for copper based on the positive demand outlook and the negative supply outlook. Glencore, of course does have copper exposure, but overall that company is quite diversified across the mining of various metals and commodities trading. Antofagasta plc ( OTC:ANFGF ) is a Chilean copper miner with established operations and growth plans for copper production making it set to benefit from the forecast rise in copper demand and probably higher copper prices.

In the last few years, we have seen quite volatile prices for copper, but the trend is clearly up, as this supply/demand imbalance in copper has already started.

A report in October from consultancy Wood Mackenzie is bullish on copper over the medium term and stated:

To meet zero-carbon targets, the mining industry would have to deliver new projects at a frequency and consistent level of financing never previously accomplished. This pathway would result in:

• The need for 9.7 Million tonnes of mine supply over the next decade from projects that have yet to be sanctioned. To date, a shortfall of this magnitude has never been overcome within a decade. This supply gap contrasts with 6.5 tonnes under our base-case climate trajectory.
• More than US$23 billion of investment a year in new projects, 64% higher than the average annual spend over the last 30 years.
• A growing market deficit, exacerbated by the sharp increase in refined demand growth. This will underpin a copper price rally to more than US$11,000/tonne (about US$5.00/lb) within five years, in contrast to US$7,010/tonne (US$3.18/lb) over the same period in our base case.

Source: Red metal, green demand - Copper’s critical role in achieving net zero, October 2022

In the near term, we then have the news that China is starting to relax its zero-Covid policies and is continuing heavy stimulus for its real estate industry. This is positive for metals and especially copper demand and so mining stocks have rallied in recent weeks. The SPDR S&P Metals and Mining ETF ( XME ) is up about 20% over the last six months.

But as Seeking Alpha readers, most of us are long term investors, not momentum junkies. And therefore I like Antofagasta for fundamental reasons on top of the positive macro environment for copper. Antofagasta has a perfect Piotroski F-Score of 9 and a safe Altman Z-Score of 3.84. It has a trailing EV/EBITDA of 6.6x vs the sector average of 6.9x. It’s rare to find a quality stock undervalued.

The world needs more copper, and mining companies have shown hesitation in investing in new mine exploration and developments, and instead focused on dividend payouts and deleveraging their balance sheets. This was because of the 2013-2016 mining downturn, which was driven by the ramp up of mining projects sanctioned following the China commodity boom in the 10 years previous to that.

There has not been a large new copper discovery for a generation. Rio Tinto ( RIO ) is a good example of the discipline shown in the mining industry over the last few years, and it’s another stock I like – with a Valuation Grade of A+. Rio decided to acquire the portion of Turquoise Hill Resources Ltd it didn't already own last year, than to invest in new copper exploration.

Chile

Antofagasta’s mines are all based in Chile and the country is the world’s largest copper producer. Codelco the large state miner in Chile and the world’s largest copper producer, producing 1.6 million tonnes from the world’s total production of 21 million tonnes a year. So, we can be confident that Chile is a mature and developed country for miners. However, Codelco’s output profile in future years is lower than previously modelled according to respected commodities analyst Colin Hamilton, as the government has tried to rein in spending.

Other supply issues are impacting overall Chilean copper supply. For example, the weather in Chile hasn’t helped. According to Anglo American plc ( OTCQX:AAUKF ), who is another large copper producer out of Chile, in its Q3 production report published at the end of October:

Chile´s central zone continues to face severe drought conditions, with the last two years up to June 2022 being the driest years since records began. While the rain and snowfall deficit decreased during the third quarter, the outlook remains very dry and these conditions place pressure on water availability in 2023.

Ironically, this lower supply outlook in Chile, supports higher copper prices. However, while Antofagasta’s important mine Los Pelambres saw a 25% drop in the amount of ore that it processed in the nine months to 30 September, which contributing to an overall 17% drop in copper production in that time period, in Q3 there was strong improvement and production rose 40% between the second and third quarters thanks in part to Antofagasta’s “ improved water availability ”.

The ongoing drought in Chile is a problem but much less so for Antofagasta which is building a desalination plant to process sea water to maintain water supplies, and this should be completed next year. Water is crucial for processing ore and turning it into copper concentrate.

Margins

Like other miners, Antofagasta’s net cash costs have been going up. They were $1.29 per pound of copper produced, in 2018, before hitting a low of $1.14 in 2020 and are now at $1.76 per pound, for the nine months ending 30 September.

In absolute money that’s an increase of $600 million assuming the 2022 production guidance of around 650,000 tonnes is hit. This hurts margins slightly, but copper price increases could more than make up for this.

The miner moved to a net cash position of $541 million at the end of 2021 but the capital expenditure of about $1.7 billion by 2023 would put the group back into a net debt position of maybe around $1.5 billion. But this is necessary spending to boost production and bring three years of significant investment to a conclusion. Phase 1 of the Los Pelambres expansion plan nearly complete and should add 60,000 tonnes a year of copper output. At the Centinela mine, Antofagasta’s second-largest mine, a new open pit is already adding to production and a second concentrator – which processes ore into concentrate, a semi-finished metal that can be exported – is being is at the final investment decision stage. If that goes ahead, total copper production could reach 900,000 tonnes a year by 2026.

Politics

Chile’s new leftist government has not been able to rewrite the country’s constitution and make fiscal terms more expensive for the country’s mining operations. The government has stated it wants to improve environmental performance at mines but not disincentivize foreign investment. This seems to be a good approach, given investors are putting ever greater focus on mining’s environmental footprint anyway.

A new tax proposal seems to be more balanced and fairer as it is based on margins and not simply copper prices. This improved Chile outlook should improve the sentiment.

Conclusion

Every mining company has challenges ahead, but the period of uncertainty is clearing around Antofagasta. It’s a well-managed pure play on copper, with a clear runway for production growth in a commodity where the supply/demand balance favours higher prices. It might be 2024 before clear results come through, but by considering the stock now, we can be ahead of the curve.

For further details see: