In terms of your agnostic investment strategy, what do you look for when considering investing in the resource sector?
We have a broad mandate which allows us to invest across all sectors in Australian small caps. We look for many of the same attributes in resources companies as we do with industrial companies, including:
- Strong management teams we can back to outperform expectations
- A realistic medium-term earnings profile at a
- reasonable valuation
- Positive sustainability characteristics — in terms of both the sustainability of earnings streams and ESG
- A fundamental
- understanding of the risks involved in the company, and adjusting position sizes accordingly
Given our investment philosophy is “earnings drives share prices”, we typically don’t buy resources stocks until there is a solid framework around resource/reserves and a feasibility study with a pathway to production in the next few years. We typically need to have a positive view on the underlying commodity, although we are more focused on internal company drivers that can deliver value that is not priced into the shares. This can include a differentiated view on things like the production and cost profile, mine life extensions, or growth projects.
Companies that we deem to have higher risk profiles, such as building or commissioning projects with elevated debt levels or with a higher position on the cost curve, have position sizes adjusted to the lower end of the typical portfolio range to account for these potential risks. For us, a good management team is hugely important in the resources space. Proven operators who have a track record of being conservative and focus on shareholder returns (rather than risky growth projects or empire building) usually deliver outsized returns for investors, especially given the volatile nature of commodity markets and mining stocks.
What are some of the trends you’ve noticed amongst ASX-listed junior miners over the past year?
Raising money has become harder for most juniors (with the exception of lithium explorers), which we expect will flow through to lower exploration and drilling activity in the coming year. Having said this, good projects can almost always attract funding, and there have been several exciting new discoveries in the battery materials space.
Building new projects has been exceptionally hard over the past few years as cost inflation and supply chain issues have seen a number of large capex increases and delays. Many ASX-listed juniors who have commissioned projects in the past year have required a “top up” equity raise to cover cost overruns and working capital. This has typically been done at a significant discount to the main equity raise price for project financing, meaning investors are less incentivized to own companies during the development period — the Lassonde Curve is more applicable than ever.
The market seems to have forgotten what happened with lithium from 2016-2018, and just how hard it is to commission new lithium mines. We are starting to see some of these issues resurface in commissioning, with target recovery levels taking longer. Investors are also discounting the potential for new extraction technologies such as direct lithium extraction (DLE), which was viewed much more positively a few years ago.
There has been a big step up in ESG practices from junior miners over the past year. Most new projects are now being designed with a renewable power component (typically solar) included, and native title engagement is becoming increasingly more important given the lengthy permitting processes. There is also a trend to call just about every commodity a “critical mineral” and highlight its use in decarbonization.
How does sustainability play into your investment process?
Sustainability means two things to us. Firstly, it is the sustainability of the business model and earnings stream of a company. This relates to qualitative factors that we research, such as industry structure, competitive positioning, the impact of technological change in an industry, growth options, and cost levers the company has available. Looking at management tenure, track record and alignment is also a big component.
Secondly, we have a dedicated ESG team that engages with companies and assesses their credentials on a range of metrics.
We score companies on both business sustainability and ESG, which feeds into our investment process. Apart from general restrictions on tobacco and controversial weapons, we don’t exclude companies from our investable universe based on sustainability issues, and we are comfortable holding stocks with poor sustainability ratings. However, this becomes a tradeoff against the return expectation. Companies with lower sustainability ratings require a higher expected return to make it into the fund, and vice versa.
What is Maple-Brown Abbott’s approach to ESG?
With respect to the resources sector, we consider carbon emissions disclosures and a company’s proposed pathway to reducing emissions, in addition to the social side of ESG — workforce measures such as safety, modern slavery, and the impact of operations on local communities. Governance is always the most important factor in small cap stocks, regardless of sector. We don’t need companies to tick all the boxes on governance at an early stage in their lifecycle, but we believe a strong board with appropriate skills and incentive frameworks are critical factors in future success.
How does the fund suit clients’ investment portfolios? Who is the fund particularly appropriate for?
The fund suits clients with a longer time horizon (over five years) who are looking for capital growth. Small caps are an inherently more volatile segment of the market, with earlier stage companies typically focused on higher growth and lower dividends than their large cap counterparts. The fund invests across all segments of the ASX-listed small cap market, with an objective of outperforming the S&P/ASX Small Ordinaries Index, with a lower volatility than the benchmark.
The fund is open to retail and wholesale investors, with a minimum investment of A$20,000.
Given the global focus on green energy initiatives, what is your view on the outlook for commodities such as uranium?
We are very positive about uranium as a commodity and have been for a few years. The stars seem to be aligning at present, with energy security issues prompting more countries to extend reactor lives, consider nuclear as a greater share of the future energy mix, and contracting activity from utilities picking up substantially. The supply deficit that has persisted for a number of years is seeing inventories drawn down, and the current uranium price is still below incentive levels for new greenfield supply to come online. Our conversations with companies and traders in the uranium industry point to increasingly favourable contract terms, including higher floor and ceiling prices well above the spot price. Our view is that uranium needs to be at least
US$80/lb to balance the market. This is a commodity that historically has spiked in price when utilities get desperate for material, and we would not be surprised to see that play out again in the next few years.
How are geopolitical factors, such as the Russian invasion of Ukraine, influencing investment decisions?
Politics is becoming increasingly more important in the mining space. The Russian invasion of Ukraine saw energy security become a critical issue, and political tensions between China and the US have seen the introduction of new legislation such as the Inflation Reduction Act, aimed at securing more supply of critical minerals. Some of these policies have been very positive for the battery materials space, with low-cost government funding and grants being handed out for domestic projects. However, the requirement for downstream processing in some jurisdictions is increasing costs and risks, especially in countries with high-cost labour and a lack of technical expertise.
The re-routing of global trade routes and supply chains will mean a huge amount of capex will need to be spent over the coming decade in Western countries. This will increase security of supply, but also lead to higher costs and inflation. We believe long-term price assumptions for many commodities will need to be revised upwards over time to account for this. We have a favourable view of contractors and mining services providers who should benefit from this wave of upcoming work.
What are some of Maple-Brown Abbott’s favourite mining jurisdictions and why?
In our view, every mining jurisdiction has its own challenges, and getting new mining projects off the ground is becoming harder just about everywhere in the world. Governments globally are carrying higher debt loads with increasing interest bills, and the mining sector is seen as a source of additional revenue through increasing royalty rates to plug budget holes, particularly in fossil fuels such as coal and oil.
Western Australia and Canada are still seen as the best mining jurisdictions globally, and in our view, projects in these regions rightfully deserve a premium. However, permitting processes are taking longer to get projects approved, and labour shortages and cost inflation are seeing increased capex and opex assumptions eating away at returns.
We are happy to invest in most mining jurisdictions, and our process around the sustainability of business models applies to this too; less favourable jurisdictions require higher returns to attract our investment. We own a handful of companies with mines in various African countries, with good management becoming a critical factor here, as companies need teams who have experience operating in the region and spend a lot of time on the ground. Due to a lack of historic exploration compared to countries like Australia and Canada, junior companies in Africa can discover very good deposits and bring them to production at a relatively low cost. Interestingly, the majority of cashflow generated by ASX listed junior gold miners over the past three years has been generated by African operations, while the older mines in Western Australia have seen increasingly higher costs and production declines.
Are there any other thoughts or predictions for the coming year you would like to share?
I believe we will see more M&A in the year ahead, particularly in the junior gold space. The large amount of money in various ETF indices means that as companies increase in size and gain index inclusion, they typically trade at a premium given the weight of passive buying that follows. This can become a self-fulfilling cycle as scrip-based acquisitions are then more accretive.
In my view, the reduction in capital raising activity will put some juniors under pressure to sell and realize a premium for shareholders, rather than slowing exploration and entering hibernation mode. Many major and mid-tier miners are struggling for organic growth options and have relatively good balance sheets, which may cast their eye more towards inorganic opportunities.
As always, most acquisitions make sense on a spreadsheet, but few add value in real life — cultural alignment and the ability to extract synergies from the operations is crucial to creating shareholder value in the medium-term.