Exxaro’s ‘money or the box’ conundrum

Three years after announcing a strategy to diversify from coal, Exxaro is…

Three years after announcing a strategy to diversify from coal, Exxaro is still searching for an investment.

Nombasa Tsengwa, CEO since mid-2022, acknowledges that it’s been a struggle trying to buy copper production in a fiercely competitive global market. In one asset chase, the company vied for Botswana producer Khoemacau Copper Mining, owned by US fund Cupric Canyon Capital. But China’s MMG proved too strong a competitor.

“If the Chinese are in the picture, they will always beat you on price,” Tsengwa says. In the end, MMG bid $1.6bn — about half of Exxaro’s current market capitalisation — and another hope bit the dust. This was despite Exxaro lining up a joint bid with a South African company whose name Tsengwa has pledged not to disclose.

It’s because of this global competition that Exxaro may go full circle by re-examining its potential for new coal production, provided the investment is in existing resources. This presents the company with an interesting ‘money or the box’ decision: either spend money on known resources in a commodity where it has expertise, or make a higher risk bet through an acquisition in a new mineral with potential upside.

Tsengwa says that the board hasn’t given her a mandate to look for new coal, which means that adopting Thungela Resources’ strategy of buying unwanted coal assets offshore isn’t on the cards. But Exxaro has extensive coal in Limpopo’s Waterberg that could bear renewed scrutiny.

“We still have reserves, such as Thabametsi; there’s a lot of power station coal there,” she says. Beneath those reserves is more export coal, but it’s deep, and, in any event, it’s only the South African government’s recently updated energy roadmap, the cabinet-approved integrated resource plan (IRP), that has potentially given the coal sector fresh impetus. Instead of aggressively phasing out coal, the IRP has taken a more moderate stance, recommending 18,000MW in coal-fired power generation by 2050 instead of the previous target of 10,000MW.

Thungela CEO July Ndlovu says the government has accepted reality. “Coal must be a part of a diversified energy portfolio,” he says. For both his company and Exxaro, coal supply to Eskom is a business case that’s making a comeback.

We still have reserves, such as Thabametsi; there’s a lot of power station coal there

Tsengwa is at pains to emphasise that her outlook doesn’t reflect a board decision. “If someone were to come and wake me up in the middle of the night and say: ‘Would you consider it …?’ I don’t have an answer.” But she adds that last year’s World Economic Forum brought home the realisation that South Africa’s renewable strategy can’t be realised to its fullest extent, at least not yet. It depends on developing a national distribution network that isn’t currently sufficient to support the scale of renewable projects in the pipeline.

In addition, the metals market took an abrupt 180° turn last year. The nickel price is 38% weaker on a 12-month basis — forcing the closure of assets owned by Glencore, Canada’s First Quantum Minerals and, potentially, Sibanye-Stillwater. Lithium, the centrepiece battery metal, is under huge pressure amid a surge in new supply. On the demand side, China’s slow emergence from Covid lockdowns has fed the metal price correction. There’s also uncertainty about the trajectory of electric vehicle (EV) sales globally.

EVs have been estimated to be 30% of all vehicles by 2030, but their adoption is wavering. As subsidies and grants intended to drive EV purchases fall away, sales are beginning to flatline. The proportion of electric car sales in the UK slipped from 16.6% in 2022 to 16.5% in 2023, the first time the EV segment has gone into reverse, according to one report.

“We burnt our fingers”

Arguably now is the time to make acquisitions, while metal prices have hit a cyclical low, but Tsengwa says her group isn’t rushing anywhere. Measured against the balance sheets of mining giants BHP, Rio Tinto and Glencore, Exxaro is a minnow, and needs to move cautiously. History also plays a role. Twice Exxaro has sought diversification and failed. In 2014, the company wrote down an iron ore project in the Republic of Congo for R5.4bn after earlier attempting to build out a ferrous division to complement its 20% shareholding in Sishen Iron Ore Co (SIOC), which it still owns. Shareholders urged the company to stick to coal.

That directive was ignored when, in 2018, then Exxaro CEO Mxolisi Mgojo spooked investors after setting out plans to invest in food and water security. It was a puzzling, unheralded switch in focus that resulted in shares in the company plummeting. Mgojo later clarified that the scale of investment would be modest, but in the end, Exxaro abandoned the move.

“We burnt our fingers,” says Tsengwa. “We’ve got a bit more time to think, and maybe coal is what we should be capitalising on, coal is what we should be harvesting, and we should be paying out special dividends.”

Shareholders will say I’ve failed to diversify, so stay in coal … I’m expecting that. But we will continue to convince them. We will look for assets

In line with its diversification strategy, Exxaro has kept R12bn-R15bn in cash aside. It’s a source of frustration for shareholders, who feel that in the absence of a deal the cash ought to be distributed. But that doesn’t look imminent, though RMB Morgan Stanley speculated in a report in February the cash could be paid out by 2025 if mergers & acquisitions (M&A) don’t take place.

For now, M&A looks like the strategy. Exxaro, which previously targeted 2024 for a deal, has abandoned any deadline. It has broadened its target metals to include the likes of lithium (it previously targeted copper, vanadium and manganese, but found the ownership in the latter too concentrated and opportunities scarce). Exxaro has also hired Richard Lilleike, former executive director of Standard Chartered M&A in Joburg, to help drive the acquisition process.

RMB Morgan Stanley analysts Brian Morgan and Christopher Nicholson say: “Were it not for the execution risk around M&A, the Exxaro investment case would be very strong; the coal business is cash generative at spot and coal price risk is asymmetrically upward skewed, the balance sheet is strong and notwithstanding an acquisition, cash returns could be very high. One can’t, however, ignore M&A execution risk, and this keeps us equal weight.”

Tsengwa says she’s braced for continued criticism on this front. “[Shareholders] will say I’ve failed to diversify, so stay in coal. They will say: ‘Give us that R12bn-R15bn you’re stashing away as a special divvy and get on with your life.’ I’m expecting that. But we will continue to convince them. We will look for assets.”

Exxaro’s Transnet problem

For 2023, Exxaro is expected to report a final dividend of about R2.7bn — equal to R11.92 per share — according to RMB Morgan Stanley. Most of the payout is made up of Exxaro’s share of iron ore dividends via its one-fifth stake in SIOC (owned by Anglo American’s Kumba Iron Ore), with 40% of earnings contributing about R700m to the payout.

One of the key variables in this regard is the coal price and the ability of Exxaro to fully exploit its export capacity — which is severely limited by Transnet. Allan Waller, CEO of Richards Bay Coal Terminal, in which Exxaro is a shareholder, estimates industrywide deliveries this year of as much as 60Mt. That would be an incredible achievement, given that exports were static year on year in 2023 at about 50Mt.

Tsengwa has her doubts. Efforts by the industry to assist Transnet, through Transnet Freight Rail (TFR), have been intensive and costly, and have yet to yield results. In the meantime, exports from Exxaro that once, in 2020, crested 12Mt (albeit as a function of Covid disruption) are expected to come in at a mere 5.4Mt for financial 2023. Exxaro’s business is set up to export 8Mt a year, which, assuming a current South African thermal export coal price of about $95/t, equates to a $247m opportunity cost.

We are putting a lot of effort … into looking at alternative means to move coal … [We] are going to have us add more tons out of Maputo than we have in the past

Owing to this, Exxaro is expected to unveil interesting numbers on exports via the port of Maputo in Mozambique. “We are putting a lot of effort … into looking at alternative means to move coal,” Tsengwa says. “I can’t share the numbers, because we are in a closed period … [but] … there have been choices the team has made in this regard that are going to have us add more tons out of Maputo than we have in the past.”

Tsengwa is supportive of private sector efforts to improve efficiencies at TFR, but it comes with challenges for her business. “Pulling us into resolving this thing in an active, practical manner to the extent that we invest money into structures … that seems to be absorbing way too much, and that … concerns me,” she says. “We’ve sort of become a pseudo-Transnet limb.” Despite this, Tsengwa says Transnet “seems to be very clear about what must be done. We seem to have a leadership at Transnet now that is willing to co-operate.”

There have been flickers of a revival in TFR’s performance. According to a report by banking group UBS, thermal coal exports from South Africa increased 44% in December compared with November, equal to a run rate of 61Mt for the first time in two years. But disappointment followed — in January TFR reported a collision on the coal line that halted deliveries for a week. By February, it forecast 48Mt in coal deliveries for its financial year ended March, compared with its 60Mt target.

It makes Exxaro vulnerable to accusations of inaction if it doesn’t set upon a course soon. Expanding its coal output is therefore an interesting option. Tsengwa says the company hasn’t answered the question yet, but in the context of coal for longer, the decline of Mpumalanga reserves is an opportunity. “Does this mean you could mobile the coal from Thabametsi to Mpumalanga? This is something we had an idea of before, especially because Mpumalanga is not growing. That’s the expansion I’m talking about, by responding to the local market.”

A version of this article first appeared in the Financial Mail’s Investor’s Monthly.

The post Exxaro’s ‘money or the box’ conundrum appeared first on Miningmx.

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