Calculus shifts on build versus buy

Investors are in for a treat as a wave of takeovers starts to wash over the resources sector.

This activity is being driven by a combination of rising commodity prices and high construction costs, which mean it has become cheaper to buy an existing project than build a new one.

BHP’s $40 billion bid for arch-rival Anglo American is a perfect example of what’s happening, as a number of factors force resources companies and governments to adjust their plans.

Copper is today’s hot commodity, thanks to its use in the electrification of everything, with high demand combining with an acute shortage of supply to lift the price by 30 per cent since early January (and 120 per cent over the past four years).

With copper today selling for around $US10,000 a tonne and tipped to rise a further 50 per cent to more than $US15,000/t, governments are facing a dilemma of their own making.

On the one hand, governments are demanding a switch to electric vehicles and an end to the use of gas as an energy source, just as they discover that the cost of the changeover is becoming prohibitive (and inflationary).

Cost might not be the biggest challenge to wider use of electricity, which is best delivered by copper wires, with investment bank Goldman Sachs warning there’s significant risk a copper shortage might lead to a ‘stock out’ moment or forced rationing.

Other metals are also starting to benefit from the same forces of strong demand from new technologies and short supply.

Silver, while widely seen as an item of jewellery, has found a new market in solar panels (already consuming 10 per cent of annual production), helping lift the price by 35 per cent since the start of the year.

Tin, which has a history dating back to the bronze age of 4,000 years ago, is undergoing a renaissance thanks to its use in electronics, with the price having doubled to $US33,000/t during the past two years.

While demand, especially from industries that did not exist a few years ago, is an obvious price driver, supply is emerging as an equally important factor.

And that’s when the role of governments becomes important: because they want to electrify everything but are not always keen on approving new mines.

In BHP’s case it has a choice of trying to buy Anglo American, mainly for its existing copper assets in South America, or accelerate plans to expand copper production at its own projects in South Australia.

The SA option is slowly moving through the planning and government approvals process, which takes time and money, whereas Anglo American’s copper mines are in production and possibly available, albeit at a high price.

The buy-versus-build choice was a centrepiece earlier this month at a resources investment conference organised by Macquarie Bank, where the most popular speakers were those talking about copper and uranium, given both are energy related in their own way.

In a report written after the event, Macquarie told clients while the long-term market for ‘new energy’ materials was not going away, a slow mining approvals process was compounding supply deficits.

The banks said delays and high costs were making it harder to deliver projects on time and on budget.

“Sector-wide merger and acquisition (M&A) activity threatens to explode as buy becomes competitive with build as companies turn outwards in their approach to growth, versus organically developing their own projects,” Macquarie said.

Citi, another investment bank, picked up the buy-versus-build theme in lithium, an important commodity to the Western Australian economy but one that has been hit by a price collapse after supply swamped demand.

The example chosen by Citi to make its point was Arcadium Lithium, a business that emerged from the merger of Australia-based Allkem and US-based Livent just in time to be caught in the lithium crash.

From a share price high of $11.77 late last year Arcadium dropped by 51 per cent to $5.76 last month, at which point the buy-versus-build investment theory kicked in, helping Arcadium’s share price to recover to around $7.

Despite Arcadium being the producer of a commodity that has fallen out of favour, Citi demonstrated that the company was “ready to go” as a takeover target for a bigger mining company or chemicals company.

“Since the merger (of Allkem and Livent) was announced in May last year, Arcadium has lost half its stock market value, falling from $US10.6 billion to five billion US dollars,” Citi said.

With capital expenditure continuing to rise, combined with the technical challenges of producing chemical grade lithium for use in making batteries, Arcadium has entered what might be called the bargain basement category because it is trading well below its replacement cost.

“We estimate it could cost at least sixty per cent more to develop a comparable lithium production base (as Arcadium),” Citi said.

“For companies looking for size, first quartile costs, and chemical expertise positioned for IRA (the US Inflation Reduction Act) tailwinds buying Arcadium could be better than trying to discover and develop lithium chemicals capability.”

In effect, Citi has applied the same principles to tipping Arcadium as a takeover target with a share price forecast to rise to $9.40, as BHP has used when making its move on Anglo American: better to buy than build.

Iron ore caution

Iron ore, another WA speciality, could also be entering a new marketing phase as Chinese steel demand starts to fall and is replaced by demand from other countries.

The long-anticipated decline of China, as its furious infrastructure and property building phase comes to an end, is a reason forecasters including those in the Department of the Treasury have been tipping an iron ore price crash to $70/t, or less.

Investment bank Morgan Stanley has dismissed that low price prediction, with its latest estimate of iron ore to rise over the rest of the year from its latest trades at $US116/t to $US125/t.

After acknowledging the slide in Chinese demand, the bank said India, South-East Asia, Africa and the Middle East are all expanding.

Morgan Stanley said all demand mattered in terms of a commodity like iron ore, and focusing on China meant missing the bigger picture, which might be one of the factors behind the conservatism seen in some price forecasts versus actual prices.

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