Why we are overweight these miners

I have just returned from a visit to Perth for the first time in two and a half years. There is a clear 2010 style echo: everything you have heard and read about ‘help wanted’ signs, $8 lattes and Uber prices super-surging appears to be true. The implications, though, are far broader. If you can’t get an Uber driver, good luck getting an underground geotechnical engineer!

With the economy booming, the recent commodity price surge (+16% YTD, 39%yoy) yet to actually filter through and state unemployment at a paltry 2.9% the pressure is building. This positive shock YTD is worth ~$94bn to Australia, mostly to WA given it is at the epicentre of the iron ore industry ($186b exports at spot prices*), LNG (Australia is the world’s 3rd largest exporter) and lithium (#1 producer and ramping). You can see why many locals want to secede and reclaim their GST receipts!

The planned capex boom (off a depressed base) seems almost impossible to deliver, and hyper-inflation for construction and production disappointment seems inevitable. However, so too do higher commodity prices given the markets are likely to remain tight. Since WA represents over 60% of Australia’s exploration expenditure (refer Chart 1) and is a clear #1 for construction activity, these are critically important dynamics for the Australian economy.

Chart 1: Exploration expenditure by state and territory

For Australia’s resources sector to deliver into its potential it clearly needs; (i) a massive influx of skilled migration and appropriate environmental permitting that can be fast-tracked; (ii) companies/executives to take the risk and order long lead time items (there are 2-3 year waitlists for critical equipment) and (iii) a whole lot of luck. The need for Australia to deliver is also critically important to decarbonising globally, with 50% of the projected growth in lithium production up to 2030 expected to come from WA.

Our base case is that the bottlenecks represent a real impediment to volume growth, and high prices for future facing commodities could persist for some time. With that in mind we remain overweight producers Independence (Lithium, Nickel), Oz Minerals and Sandfire (Copper) and BHP (diversified):

• For Independence (ASX:IGO), our positive thesis remains premised on the miner’s recent Greenbushes acquisition, its takeover of nickel miner Western Areas (WSA) and its existing portfolio of high-quality assets. The Greenbushes acquisition provides exposure to a high-quality, long-dated asset (>20 years mine life) and completes IGO’s suite of battery commodities with the company already producing nickel, copper and cobalt. The WSA acquisition diversifies production (rebalancing commodity exposure to 70% Li, 30% Ni) and extends the mine life for nickel production (currently through its world-class Nova asset).
• Our positive view on Oz Minerals (ASX:OZL) remains premised on its two high quality, long life, 100% owned copper mines in South Australia - Prominent Hill and Carrapateena. We expect the company’s copper production to double to >200ktpa by 2030, as Carrapateena moves to a block caving operation, and as the company develops the greenfield West Musgrave copper/nickel deposit in Western Australia. OZL is well positioned to fund growth through its net cash balance sheet, strong cash flow generation, and flexibility to divest assets (e.g. the Centro Gold deposit in Brazil). We also support OZL’s plan to achieve net zero scope 1 and 2 emissions by 2030, which we view as ambitious and considered.
• For Sandfire Resources (ASX:SFR), we view the MATSA acquisition as a high-quality operation, comprising three underground mines in Spain that produce mostly copper and zinc and a processing plant with capacity of 4.7mtpa. Importantly, the purchase extends SFR's mine life across its operations and resolves the looming earnings hole in FY23 as SFR's main existing asset, Degrussa, ceases operating.
• We view BHP (ASX:BHP) as attractive given its valuation, strong free cash flow yield (>10%) and robust balance sheet, with management carrying out a well-defined capital allocation strategy. However, more broadly we are negative towards the outlook for iron ore on the grounds that China’s property sector faces significant challenges (and hence steel), with our underweight reflected in underweights Rio Tinto (ASX:RIO) and Fortescue Metals (ASX:FMG).

In light of the bottlenecks we can see, we remain underweight those companies with large, speculative/blue sky projects.

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* As at 27 May 2022.