For Kerr, the deal is a sort of double punt.
Clearly, the opportunistic deal is a wager that South32 can extract value from an ugly-duckling mine that others didn’t want to touch. Some of that risk is defrayed by the price Kerr has paid – South32 is paying 3.3 times trailing earnings before interest, tax, depreciation and amortisation, in a world where copper pure-play miners are trading at 10.1 times EBITDA – but there will be scepticism from some whether Sierra Gorda’s problems are behind it.
Kerr is unbowed and sees opportunities to ramp up production at the mine, including through de-bottlenecking parts of the project.
The second punt is that buying a productive copper mine will give South32 access to the decarbonisation thematic that is dominating ESG-obsessed global capital markets, given copper’s vital role in the electrification of the planet.
This clearly makes financial sense; the 50 per cent rise in the price of copper over the past 12 months speaks partly to rising demand from post-pandemic recovery, and partly to the acceleration of electrification in the energy transition.
The deal is immediately earnings accretive, but should also be a winner over the longer term. South32 sees a copper supply deficit emerging in the second half of this decade, which is likely to grow as demand from electrification rises and declining copper grades weigh heavily on supply.
But a shift into copper – Sierra Gorda will mean South32’s EBITDA contribution from the base metal will rise from zero to 19 per cent – also has the benefit of giving South32 a green tinge in a world where ESG issues are making some investors sell first and ask questions later.
Like BHP, Rio Tinto and other global giants, Kerr has been previously unwilling to buy copper assets because of high prices, and has instead been happy to try to get exposure to copper via exploration – or, as he likes to say, “creating value through the drill bit”.
But this strategy takes time – often decades, in the case of copper. That Kerr has been prepared to push the button on a deal – albeit for a renovator’s delight – might suggest that the pressure to give South32 a greener tinge is becoming a little more intense.
Note the way the miner sold the Sierra Gorda deal on Thursday. Not only did it say the deal “reshapes our portfolio for a low carbon future” and delivers a “substantial increase in our earnings leveraged to the green energy transition”, but South32 even claimed its entire portfolio has some link to the energy transition.
There are base and precious metals for electric vehicles and renewable energy (43 per cent of the portfolio), aluminium as a lightweight metal for EVs and construction (36 per cent), manganese for steel production, recycling and EVs (18 per cent), and even high-quality metallurgical coal (3 per cent), which South32 says will be vital for steelmakers reducing emissions.
Some might take issue with this characterisation given the emissions from aluminium smelting and steelmaking, but it neatly illustrates the need for mining and energy giants to sell themselves to capital markets as part of the solution, rather than part of the problem.
South32 shares rose 5 per cent on Thursday, taking 12-month gains to 80 per cent.
But if you need further evidence of why Kerr and South32 would be so keen to get their decarbonisation message across, look no further than Whitehaven Coal, where chief executive Paul Flynn said on Thursday that thermal coal prices were so strong that the company will soon have paid down its debt and would move into a net cash position in the March quarter of next year.
Whitehaven shares have doubled to $3.24 in the past six months as coal prices have taken off, but veteran mining analyst Peter O’Connor, of Shaw & Partners, says the stock remains “extraordinarily cheap” and should be trading at $10 given how tight the coal market remains going into the northern hemisphere winter.
This disparity between the market’s valuation and O’Connor’s estimate perfectly illustrates the change that is under way in global capital markets.
When even hard-headed, return-obsessed investors won’t touch such an obvious opportunity, you see how ESG concerns are transforming the cost of capital for the resources sector.
Read More: Miners reveal the brutal reality of ESG