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This transcript is a translation from the original interview, which was conducted in Afrikaans and aired on RSG Geldsake, here.
RYK VAN NIEKERK: Mines are one of South Africa’s most important economic sectors and although they contribute only 8.7% to the gross domestic product, they also support various other sectors such as the manufacturing and logistics sectors. The mining sector provides more than 460 000 jobs and in 2021 paid the government around R120 billion in tax and royalties. If employees’ income tax in this sector is included, that provided R150 billion to the fiscus. The sector also exported minerals worth R840 billion.
Kobus Nell is a portfolio manager at Stanlib and is on the line. Kobus, a warm welcome to the programme. The figures I have quoted come from research by the Minerals Council [of South Africa] relative to 2021, and in many respects 2021 was a record year. How do mining sector activity levels for this year, 2022, compare to those of last year?
KOBUS NELL: Hello Ryk, and hello to all the listeners. I think if one looks at this year as a year in which South African mining companies profit[ed]… greatly from the relatively high prices of platinum group metals in particular, and secondly from coal. That’s a huge advantage that government has enjoyed in a very difficult period in terms of the additional taxes it could collect.
In the fiscus we saw the degree to which income was derived from mining activities and how, I might say, it plugged holes.
And, if I look at the country’s indebtedness, even when things looked desperate through the Covid period with the additional expenditure, it was in the serious position getting back to that level of indebtedness. As you mentioned, that doesn’t include the benefits for workers who are totally dependent on maize, or what it meant for all the other industries around the mining industry. That certainly had a very good impact on South Africa this year.
RYK VAN NIEKERK: You referred to the platinum group metals which did well, but in your view which commodity sector or segment in our mining industry performed best or perhaps the worst? Which of these stood out?
KOBUS NELL: Ryk, the best by far were companies with pretty big exposures to coal, because that was the commodity that – if one looks at its price movement – went up almost in a straight line. Companies that benefited greatly from coal are Thungela, which was almost 2X or 250% up in the year to date. And then companies like Glencore, which also has a big exposure to coal, was almost 50% up. Exxaro as well, which has a relatively high exposure to coal, although much of its coal is sold to Eskom at fixed tariffs, also went up almost 50%. So those definitely stood out.
And if you look at coal itself, coal is just a little over 100% up year to date. That was definitely the one where one could see the difference.
I think it is however important to give a little background to these high coal prices. Coal is an alternative to the very high gas prices seen in Europe, where coal is basically viewed as an alternative energy source to gas, with a sort of price-movement relationship, especially in Europe.
Of course, the gas price rose so steeply because of Russia which – as has been widely discussed during the year – severely restricted its supplies to Europe. As we saw, that caused massive damage to the European economy … But for those selling coal it has been a fantastic year.
RYK VAN NIEKERK: But I also think that here coal and in particular iron ore have been negatively affected by the problems Transnet experienced and the problems we had in getting products aboard ship and exported. It is one thing for the price to be high, but if you can’t get it to where you want it, or where people are prepared to buy it, the opportunity will dissipate.
KOBUS NELL: Absolutely, Ryk. As you see, if the product is there and our buyers are there, you can realise those types of profits – not only for the company and others, but, as I said, to the benefit of the country and its taxpayers.
Yes, I think it’s very frustrating. Speaking to mining companies during the year one could really hear the great frustration, and one would hope that proper attention is being given to the matter. It’s such an easy source from which we and the country can capitalise, and we have unfortunately just not seen that functioning.
RYK VAN NIEKERK: And then which industries do you think fared worse than others?
KOBUS NELL: If you include the packaging companies, Mondi had a really poor year. It was one of the poorest shares in terms of returns, and that is something rarely seen. Mondi was usually in the middle of the pack. It had a very difficult year. Nevertheless, the company is still looking at relatively good companies it might wish to buy, as well as an improved dividend on that side. That was rather interesting.
Our precious metals for this specific year did not do that well. If you look at platinum in terms of 4% … not a big rise there. But the really big price increases were lower than last year. Absolute price levels are still very high and the margins are still very high. But for a mining industry to really do very well in terms of yield one often needs to see that the underlying metals or commodity price must rise. This has held the platinum companies somewhat back this year because they were up between 4% and 3%, perhaps not what many expected, and they seem very cheap if one looks at the multiples. And, as I mentioned, the prices at absolute levels are still very high and in many investors eyes I think perhaps at levels they don’t consider sustainable.
RYK VAN NIEKERK: Generally, when there is a surge in the industry and the mining companies get some cash into the bank one sees a flush of corporate deals. We haven’t seen that many this year. Impala Platinum and Northam are competing to take over Royal Bafokeng Platinum. It’s an interesting fight. And then Gold Fields wanted Canadian Group Yamana, but that deal also fell though. Chris Griffith resigned as chief executive after that happened.
Did I miss any other big transactions that took place?
KOBUS NELL: Not really, Ryk. Rather, it was in the previous year and years before that that many of the companies tried to rid themselves of coal, the environmentally unfriendly exposure. And among those are unbundlings like Thungela, coming from Anglo American. But looking at mining companies’ overall margins last year and even this year, it’s really amazing that the mining companies – and I’m speaking of global mining companies – were so disciplined. As the main reason, if listeners think back, some might remember that in 2014/15 there was a huge bear market in the commodity world. Some of these companies were literally on the point of looking at rights issues or at selling big assets, having taken on huge indebtedness from, one might say, 2008 to 2012 …
So you had profit margins as high as those in the good times from 2012 onwards, when the Chinese had a great deal of credit and high demand in 2008, just before the global financial crisis, and the Chinese had strong growth. They did not substantially increase their purchases. That’s why one now sees very strong free cash flow for many of these companies.
The one exception, perhaps – and you mentioned it – is the love triangle between Impala, Northam Platinum and Royal Bafokeng Platinum, where Impala and Northam Platinum are targeting Royal Bafokeng Platinum’s land. The land [ore body] still has a very long life, is relatively shallow and in an area were we have seen very little expansion in the past who knows how many years. With the situation in terms of electric vehicles, the reduced number of traditional vehicles using traditional platinum catalytic converters, there is great uncertainty about the demand going ahead for those metals and those vehicles. That may be why we have seen very little investment. But the assets that remain buoyant are what the guys are fighting for.
RYK VAN NIEKERK: Then finally, what do you expect for next year?
KOBUS NELL: Ryk, I think if one looks at investment in commodities, one has to consider cycles. They are cyclical investments, when one looks at them, and I think they will always be. If we look back, mining companies reached their peak on a relative basis around February 2022. In literally a year, from February 2021 to February 2022, the mining sector went up a little more than 60%. There have been companies up much more, but the average was 60%.
Interestingly, from February 2022 – when the Ukraine-Russia war broke out – we saw those highs. And if you look at some of your indicators for copper, oil, the movement in the dollar – you usually see strengthening of the dollar in a bear market – and some other things, they indicate that the bear market possibly ended in February 2022. That has of course not been confirmed, but since then mining shares have underperformed, especially if one considers them on a relative basis. So I think that’s the first important thing we went through.
If one excludes the three months during Covid when commodity prices fell heavily but quickly recovered, we had seen a very extended commodity bull market – basically counting from 2016 to, say, the beginning of this year.
So I think one has to keep at the back of one’s mind that mining company margins were at record high levels, as high as we saw in that exceptional period for commodity demand. So I think if all that is put together and you look at normalised earnings and at those sort of things, the mining sector is not trading at exceptionally cheap levels. Because of the very high current cyclical margins it might look seem so, but that wasn’t the case. So I think one has to realise that was a great period, but it is behind us.
As for next year, the one thing I consider significant is the rise in interest rates which seems to ‘want’ to abate or slow down, as we have seen.
Usually that happens at the point [when] commodities are also not doing too well. I think in 2023 we will be entering such a period. We are talking of interest rates not being cut, but possibly abating. That will be negative.
Then I think the Russian war will be more widespread. Its pushing of gas and coal prices up is not good for demand, because many businesses cannot operate profitably. That’s also a negative we need to look at, the economic downturn in Europe. They consume some 20% in base metals, 10% to 15% in iron ore, and even 40% to 50% in platinum group metals. That, too, is a big risk.
And finally, as we say, the only positive that we could see is China’s reopening which you could have seen since they announced trading again in commodity prices. But it is primarily energy that they expect – and oil prices – can be supported if there is greater activity. Again, that does not bode well for mining companies’ input prices.
I think it’s going to be a more difficult year, Ryk, following a very good period for investors. But I think there are still specific opportunities that one might see, depending on how the war in Ukraine plays out and has an impact. But I think one has to see it as an investment relatively late in a cycle which could be full of challenges in 2023.
RYK VAN NIEKERK: Kobus, thank you so much for time this evening. That was Kobus Nell, a portfolio manager at Stanlib.