Welcome to the April 2022 edition of The Markets in Three Charts.
For this edition, we have found some interesting social, economic, and share price charts in order to illuminate some of our investment ideas. This month we will be discussing the links (in our estimation) between electrical vehicle demand and copper consumption, in the context of one of the Fund's long-term holdings, Hillgrove Resources (ASX: HGO). Please note we are presenting general insights into our decision-making, not investment advice.
Chart 1 - Outlook for annual global passenger-car sales to 2030
All you have to do is walk down a street in a neighbourhood with above average house prices and you'll see (not hear) your fair share of shiny red Teslas. Although their proliferation on the road feels significant, the chart above shows that battery-powered electric vehicles (BEVs) accounted for less than 8% of passenger cars sold globally in 2021. Internal combustion engine (ICE) vehicles still lead the way - for now. Demand for BEVs and plug-in hybrid electric vehicles (PHEV) is forecast by Deloitte to soar in the coming decade, with total EV sales of 31 million in 2030, growing 29% p.a. from today's 2.5 million. Accordingly, EVs will represent around 30% of all passenger cars sold in 2030. This anticipated trend is largely driven by the need to reduce carbon emissions and the legislation of countries such as the UK, which have committed to banning the sale of new ICE vehicles from 2030.
The expected dramatic increase in EV demand will require an immense amount of various metals needed for battery and motor components. These include graphite, aluminium, nickel and copper. Each BEV requires around 80kg of copper, four-times that of a traditional ICE. Copper has several applications in BEVs, including about 1 mile of wiring in electric motors. It is also used in batteries, inverters and charging stations.
CHART 2 – 10-year copper price (US$/tonne)
Source: Reuters Refinitiv
As evident, the price of copper has soared over the last couple of years, increasing by over 100% since April 2020 (albeit off a Covid-impacted base). This has been driven by a number of factors, including global infrastructure spending, demand for certain whitegoods, and supply constraints. Regarding the latter, Covid-induced lockdowns in Chile, the largest producer of copper, impacted supply during 2020-21. Over the last few months, Russia's invasion of Ukraine has raised further question marks, since Russia controls around 10% of global copper reserves.
There is also a growing awareness of the future need for copper in the world's electrification and renewable energy transition, most pertinently in the transition to electric vehicles. Of the 22 million tonnes (mt) of primary copper consumed in 2021, 2mt (9%) went into passenger cars. In 2030, due to the increase in BEV production, this should be around 4mt (18% of current consumption), a two-fold increase. Outside of BEVs, copper will also be required in other aspects of the energy transition, including solar and wind.
According to the independent consultancy Rystad Energy, total copper demand will increase by 16% by 2030, while supply is set to dwindle by 12%, leaving a shortfall of 6mt p.a. The decreasing supply is due to an historic underinvestment in new copper projects (owing to a decade of low prices). For this to reverse, the copper price will have to increase, a trend we have begun to see.
The biggest risk to Rystad's shortfall thesis is China, which accounts for 50% of annual copper consumption. In turn, around 20% of China's end use is in the construction sector, which we know is under pressure due to the country's current property sector crisis. Around 40% is used for manufacturing whitegoods and machinery, much of which is dependent on global growth and urbanisation. Nevertheless, for Rystad's demand scenario to play out, copper consumption would only be increasing by 3.5mt p.a. by 2030. Considering the passenger-car industry alone could be consuming an extra 2mt p.a. by then and global population growth and urbanisation is likely to continue, a slow-down in China would not necessarily see global copper demand fall dramatically.
CHART 3 – 6-year share price of Hillgrove Resources (ASX: HGO)
Source: Reuters Refinitiv
H&G High Conviction Fund has 7% of its portfolio invested in Hillgrove Resources at an average cost price of 4c, having held shares in the company since 2016.
What does Hillgrove do?
Hillgrove owns 100% of the Kanmantoo Copper Mine project, which is 55km from Adelaide. Kanmantoo has already produced 137,000 tonnes of copper from open pit mining, which began in 2011 and was depleted in 2020. Over the last two years, Hillgrove has been drilling for copper underground in Kanmantoo and as evident in the chart above has made some promising discoveries. This resulted in a mineral resource estimate published in December 2021 documenting 63,000 tonnes of underground copper. In addition, Hillgrove released an economic feasibility study, illustrating the project would be worth $166m based on current drilling results. This equates to a return of 389% on the capital investment required to commence mining.
The company intends to start mining in the fourth quarter of 2022 and in the meantime is finishing its drilling campaign with a goal of increasing the resource estimate of copper in the ground (and accordingly improving the economics of the project) and finalising debt financing. In addition, the company holds over 600,000 hectares of exploration licences nearby the Kanmantoo mine, which could allow the company to be a major copper producer for the years to come.
What attracts us to Hillgrove?
In the context of a high commodity price and only 21 ASX-listed pure copper mining companies, Hillgrove stands out for several reasons. It is located favourably, only 55km away from a state capital. It has a fully operational processing plant, which is on care-and-maintenance since open pit mining ceased. This and the existing decline of the open pit significantly reduce the up-front project cost, which at $26m is one of the lowest in the world. In addition, having already produced copper at this plant, the risk of production issues is minimal compared to a new build. The project is also fully permitted. We are impressed by the managing director, Lachlan Wallace, who was formerly Hillgrove's mining manager and helped turn around problematic open pit operations in 2015-19. Since becoming MD in 2019 he has underpromised and overdelivered, having driven the underground project from concept to near-term reality.
Considering these positive characteristics, we believe Hillgrove is cheap at its current market valuation of $95m (8c per share). There is already 70% upside compared with the preliminary economic study of $166m mentioned above. This analysis was only based on mining around 60% of the resources inferred to be in the ground based on drilling up to December 2021. Accordingly, there is scope for this to be materially increased in the coming months, thereby considerably improving the economics of the project.
What does the future hold for Hillgrove?
The company expects to announce an updated resource estimate, debt financing arrangements, and a final investment decision by the end of this quarter. Once underground mining commences, we would expect a re-rating of the company's valuation, at least in line with the current value of the project, i.e. a base case of around 14c per share (75% upside on the current price). Hillgrove should generate around $80m in operating cash flow in 2023, which would allow it to pay a handsome dividend to shareholders and conduct significant exploration of its 600,000 hectares worth of copper exploration tenements. If successful, it could become a significant long-term copper producer and help address the anticipated commodity shortfall.
Thank you for reading. If you'd like to know more about H&G High Conviction Fund, please contact Joseph Constable: +61 431 886 186.
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Equity Trustees Limited (“Equity Trustees”) (ABN 46 004 031 298), AFSL 240975, is the Trustee for H&G High Conviction Fund. Equity Trustees is a subsidiary of EQT Holdings Limited (ABN 22 607 797 615), a publicly listed company on the Australian Securities Exchange (ASX: EQT).
This newsletter has been prepared by H&G Investment Management Ltd (ACN: 125 580 305; AFSL: 317155) to provide you with general information only. In preparing this report, we did not take into account the investment objectives, financial situation or particular needs of any particular person. It is not intended to take the place of professional advice and you should not take action on specific issues in reliance on this information. Neither H&G Investment Management Ltd, Equity Trustees nor any of its related parties, their employees or directors, provide and warranty of accuracy or reliability in relation to such information or accepts any liability to any person who relies on it. Past performance should not be taken as an indicator of future performance. You should obtain a copy of the Information Memorandum before making a decision about whether to invest in this product.