Antofagasta – buy before the market reheats

Now, however, we have come through a copper bull market and costs are rising. This leaves the Chilean miner in a more precarious position than a year ago – when copper prices were over $10,000 (£8,3,30) a tonne and costs were low, despite some Covid-19 and labour headaches. 

There is also a new government in Chile to consider and new macroeconomic conditions in place. But even in this changed environment, Antofagasta is a good horse to pick for the energy transition. Consultancy Wood Mackenzie has forecast that $23bn of new spending is needed every year for the next 20 years to guarantee enough copper supply for the global take-up of electric vehicles plus the roll-out of renewable energy and enhanced infrastructure. The pipeline of new projects is also limited. “The industry will have to deliver new projects at a frequency and consistent level of investment never previously accomplished,” the consultancy said in a recent report. This points to copper prices going up.

Blue sky mining 

Across the mining sector, it looks like the major operators’ profit levels have peaked, especially those that rely heavily on the iron ore price – Rio Tinto (RIO) and BHP (BHP). They still operate on cash profit margins of around 50 per cent and have manageable debt levels, so a 2013-2016-style downturn is unlikely. Metals supply is tight, given the reluctance of the majors to spend heavily on increasing output while prices are high, as has happened in the past. This means prices are likely to stay higher than in previous downturns. 

But dividends are also likely to start dropping after two years of record distributions. 

Thus a 2023 bull case relies on China quietly ripping up its zero-Covid policies and continuing heavy stimulus. A moderation of China's current approach looks increasingly likely. This month shares in miners have rallied strongly on hopes China is coming close to withdrawing rules such as daily Covid tests in cities and lockdowns for any cases, so the market is certainly optimistic. And while Xi Jinping’s government has not yet outlined any major paring-back of Covid rules, new support for the real estate industry (supporting steel and copper demand) show the president has not abandoned growth plans. 

Looking beyond the next 12 months, there is more certainty in the copper space. Put simply, the world needs more copper given the demand outlook for the next decade. The miners’ hesitation to launch huge capital-spending programmes to increase output has helped both the red metal’s price in recent years and their balance sheets, but this will lead to supply shortages by the middle of the 2020s. Permitting difficulties in the US and several South American countries have exacerbated this scenario. 

Chile weather

The world’s largest copper producer, Codelco in Chile, epitomises this. It is responsible for 1.6mn tonnes a year, compared with global production of 21mn tonnes. “Having worked some operational quasi-miracles to sustain output in recent years despite depletion of aged assets, the full impact of years of underinvestment [by Codelco] is now becoming clear, with the net result being an output profile in future years lower than previously modelled,” says BMO Capital Markets analyst Colin Hamilton. "This reinforces the long-held trend of stagnant Chilean output, and helps to tighten forward balances at a time when wider market concerns over mine output growth in 2023 were at the forefront of discussions.” 

A rise in copper output had been forecast for the second half of this year, through production increases at existing mines and a new Anglo American (AAL) asset, Quellaveco. In September, Anglo cut its 2022 guidance for Quellaveco's output from 100,000-150,000 tonnes to 80,000-100,000 tonnes. Anglo has also seen lower production from its Chilean mines, with a fall of 30,000 tonnes in the September quarter alone. This was largely due to mining conditions, but Anglo also flagged drought as a continuing risk to production. 

“Chile’s central zone continues to face severe drought, with the past two years up to June 2022 being the driest years since records began,” the miner said. “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.” 

The slight benefit of reduced production during drought – less supply supports higher copper prices – is easily outweighed by the risk to supply. Antofagasta’s key mine Los Pelambres saw a one-quarter drop in throughput (how much ore is processed) in the nine months to 30 September, contributing to a 17 per cent drop in copper production. The mine was running at half capacity at times in the second half. 

Happily, there was some improvement in the September quarter, with production climbing 40 per cent between the second and third quarters due in part to “improved water availability”. In the longer term, an in-construction desalination plant should help Antofagasta maintain water supplies. This will be finished next year. 

The numbers

Antofagasta’s production has come down and its costs have gone up. There are a few ways to understand this trend. The miner uses a measure called net cash costs – this is the overall cash cost of copper produced (excluding capital expenditure), presented on a per-pound (lb) basis, minus the impact of selling by-products. These vary by mine but are mostly gold and a common alloy ingredient, molybdenum. The industry’s accounting quirk means these sales are counted as negative costs rather than revenue. 

This net cash cost figure has bounced around in recent years – it was $1.29 per lb in 2018, before hitting a low of $1.14 in 2020. This has climbed to $1.76 per lb in the nine months to 30 September. The difference between last year’s $1.20 per lb level and $1.76 is over $600mn, given the 2022 production guidance of around 650,000 tonnes. This is not going to tip the group into a loss since the copper price remains over the marginal cost of production, but it is worth flagging that the next year or so will see profits come down.

Broker Peel Hunt thinks Antofagasta's expansion plans will make the balance sheet weaker – for next year, delays in getting the desalination plant running mean the broker has cut its production forecast from 746,000 tonnes to 700,000 tonnes, and cut forecasts for earnings per share and cash profit by 10 and 11 per cent, respectively. The 2023 cash profit figure of $2.5bn will certainly be a hefty downgrade on last year’s record result of $4.8bn.

But there is room for lower earnings – the company moved to a net cash position of $541mn at the end of 2021, a swing of over $1bn compared with the end of 2019. Peel Hunt says the expansion spending ($1.7bn forecast in 2023) means the miner will again be a net borrower, to the tune of $1.6bn by the end of the year, up from the previous forecast of $800mn.

All this spending should position Antofagasta well for leaner times: the past three years has seen significant investment into new production. The Los Pelambres expansion plan (phase 1) is in its final stages and will add 60,000 tonnes a year of copper output. At the Centinela mine, the company’s second-largest operation, a new open pit is now contributing to production and a second concentrator – which turns ore into 'concentrate', a powder containing copper – is being considered. If this goes ahead, the miner’s total copper output could reach 900,000 tonnes a year by 2026. 

The politics

Chile is in a period of change. The process to rewrite the country’s Pinochet-era constitution has thrown up challenges and surprises – including voters rejecting the new text and several attempts at upping mining taxes. The latest mining tax would see tax rates on a copper mine go from a range of 31-37 per cent, depending on profit levels, to 33-54 per cent. A proposal that was voted down would have had a top tax rate of 68 per cent. 

“The better Chile outlook should improve consensus target multiples and improve sentiment today,” says RBC Capital Markets analyst Tyler Broda. “However, we would expect eventual earnings downgrades to flow through.” He also called the new tax proposal “more balanced, and more fair” as it is based on profit margins and not the copper price. 

Antofagasta’s bosses have been measured about its taxes going up. “There is... a genuine desire to try to reach the right balance between increasing tax collection for social purposes, which the industry supports, but at the same time keeping investment competitive,” chief executive Iván Arriagada said last month. 

Those discussions continue – with the company and its lobbyists likely more vocal behind closed doors than Arriagada will be publicly. But, while it’s clear the group has challenges ahead, its likely growth in cash profits is rare among the top miners.

True, the diversified miners have strong balance sheets, but the outlook for iron ore is not so firm. Glencore is reaping the rewards for its coal holdings but continues to highlight the strength of its energy transition-exposed portfolio, which includes copper, nickel and cobalt. Antofagasta’s advantages are that it sits on significant reserves and has already put billions into the future of its mines – the desalination plant is evidence of this. It will be a leaner 2023, but we see value for the longer term. Buy.