Copper is a key proxy for the well-being of the Chinese economy, given its use in infrastructure expansion and urbanization. The price of copper is down nearly 18% since the highs reached this year. Yet if one were to stop looking at the futures market, and instead focus on the deals going through in the physical side of the market, the pricing would not be as harsh. According to industry reports, the copper market is in a tight market for at least the next two years, moving to a deficit by 2020. Since the investments made earlier in the decade, there has been very little new investment to bring more copper online. For this, the companies need to be incentivised and for that the copper prices need to be at a sustainable, lucrative level.
But other than the knee jerk traders buying and selling copper as a proxy for the China/U.S. trade wars, what are the big mining companies doing? Just yesterday China's Zijin Mining Group swallowed up a huge undeveloped mine in Serbia for $1.41 billion. BHP Billiton (BHP) and Glencore (GLNCY) have made similar advancement in their copper portfolio. There has been no change to the secular story for the electrification of transport and its use in infrastructure development. We have not had any announcements in copper deals until this year. The main problem is that many assets are not for sale or they're in very difficult operating locations. Annual copper production is concentrated amongst the big four players, BHP, Glencore, Anglo (NGLOY) and Rio Tinto (RIO) . New mine development projects have been sanctioned until now. Anglo American announced in July that it will build a $5 billion copper mine in Peru.
But the one player that got hit the most for moving in the same strategic direction was Kaz Minerals (KZMYF) . They paid $900 million for a new copper deposit in Russia and lost about 50% of its share value! From the date of announcement, it has lost $2.5 billion worth of value. Seems rather dramatic for a company that has built its reputation acquiring assets and then developing them with operational excellence. The issue with this acquisition is that investors need to take a long-term view on the copper market as production will not impact it till 2025 but will cost about $5.5 billion to build. Companies are not like investors, they do not think of their share price quarter to quarter but plan for the next decade if not more. Kaz Minerals has one of the fastest and strongest growing copper profiles in the sector, as it produced almost 140,000 tons of copper from its Aktogay and Boshakol projects, an 18% increase in the first half of this year over 1H17.
This new asset could produce about 330,000 tonnes of copper over the first 10 years of production. To put it in perspective, 2018 annual copper production is about 270,000-300,000 tonnes, so we are talking more than near doubling over the next decade.
To be positioned in such a key commodity that is starved for growth and development is an extremely sensible strategy. But for a company to lose $2.5 billion worth of value for an asset that cost $900 million seems a tad bit harsh, no matter how uncertain the market is on the back of an Emerging market demand collapse or U.S./China trade tariffs impacting the Chinese economy.
The issue is not the asset or the price paid. It is the timing. Today when investors are not sure whether the floor for copper is $6000/tonne or $4000/tonne, valuations are meaningless. At the end of the day, what drives a commodity price is its inventory balance, even if distorted temporarily by its perception. Let's not forget, every day the copper price is averaging $6000/tonne, the company is still earning revenues on its 300,000 tonnes of annual copper, generating an EBITDA in 1H18 of $690 million with a free cash flow of $308 million. It is extremely cash generative and maintains one of the lowest cost quartile positions on the curve. At times of distress, it pays to do your homework.