Insight Conversation: Christopher LaFemina, Managing Director, Jefferies

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The managing director of global metals and mining equities research at investment bank Jefferies talks to Diana Kinch and Paul Hickin about market trends as the COVID-19 crisis gradually eases, and how the industry might develop in the longer term

But our view is as long as you have dramatic swings in demand due to lockdowns or lockdowns being lifted, you will see continued volatility in commodity markets. It’s not uncommon for commodity prices to experience a lot of volatility at troughs in the cycle. And it’s hard to argue that the first quarter of 2020 from a demand perspective, at least, was not a trough.

Do you think the coronavirus pandemic will significantly change companies’ business models?

Even before the pandemic came, the mining sector was in the midst of a really serious fundamental change. And if you look back to the history of the industry, mining companies tended to go into downturns with a lot of debt, and the industry tended to get in trouble in the weak points of the cycle because of over-leveraged balance sheets.

So in 2008, that’s what happened. Companies had made big acquisitions and built very expensive projects at the peak of the cycle and then lo and behold, the downturn happened when we least expected it and companies got in trouble. The same thing happened in 2015.

One of the notable differences even before 2020 is that the balance sheets effectively became sacred. So I think this kind of focus on financial strength and flexibility, and ability to withstand the volatility in markets and withstand deep downturns, is a relatively new phenomenon in mining.

I would think that the pandemic impact will only enhance that kind of philosophy, which is that balance sheet is sacred. We need to be conservative around capital allocation in general.

Are we going to see any more merger and acquisition activity on the mining scene in the near future? In theory, some of the assets are quite cheap, and companies like Rio Tinto and Anglo American have been talking about acquisition and diversification.

This is a very important question. The answer will be different than it has been in prior cycles. Historically speaking, mining companies like Rio Tinto or BHP, for example, had very large organic growth pipelines, and they were growing their production at least in line with global GDP growth. And they had a portfolio of options, projects that were not necessarily economic at the time, but over time would become economic and would be developed.

This pipeline of organic growth really limited the need to go out and buy growth. Now it doesn’t mean that companies didn’t make acquisitions anyway, but the point is they had organic growth pipelines. Because of the China supercycle and an expectation that demand might be good for a very long time, a lot of these projects that would have essentially been out-of-the-money options became in the money and were ultimately developed.

So the downturn we saw in commodity markets that began in 2011, I would argue, was more a function of supply growth than demand weakness. You had a lot of investment in new capacity, capital expenditure went to all-time high levels. All this new mine capacity came online, you had a world of new supply that crushed commodity markets and drove the downturn in 2015.

Ultimately, that supply has effectively all been absorbed into the markets today. And now those same companies that delivered that organic growth simply don’t have the growth.

So, rather than going out and spending on acquisitions or even on high risk projects, the bias in the industry has been instead to return capital. But when these companies do want to grow again, they won’t be able to do so on a large scale organically… the only option really is to go out and acquire growth.

And then the question is, do you go ahead and buy stakes and assets, do you buy individual operating assets? Do you go out and spend a lot more money in exploration? Or do you go out to make large-scale acquisitions?

I do think the industry will transition to a little bit more of a growth mentality as the global economy recovers and that will lead to an increase in M&A activity. Again, probably starting small, but ultimately becoming, as we’ve seen in prior cycles, large-scale transformational type deals.

In terms of where they will look, it’s pretty clear that the major miners, at least, want more exposure to copper and they want more exposure to kind of new-age commodities, battery materials, for example. Things like lithium, maybe even potash, but again, copper and nickel. I think these are the commodities where the investment will go in the future, not only for organic growth projects over time, but also in terms of M&A.

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