MATHEW HODGE | Morningstar Australia

· Podcast Episodes
How much of our iron ore, coal and copper does the world really need? Mathew Hodge from Morningstar Australia

"Australia’s mining industry is a pillar of the Australian economy, with the country being one of the world’s largest exporters of coal, iron ore, bauxite, alumina, and many other resources. The gross value added by the mining industry was in the hundreds of billions of Australian dollars in the past decade alone. The real gross value added of the mining industry accounted for over 10 percent of the total gross value added in Australia, making it one of the largest economic industries in the country. Over 180 thousand people were employed in the Australian mining industry. Historically, several mining booms have increased investment in mining, leading to higher incomes from mining activities and more immigration to Australia." - Mining industry in Australia - statistics & facts | Statista

Matthew Hodge is the Director of Equity Research for Morningstar Australasia. He is a mining analyst who started out working in the mining industry. I've been looking for a while to find someone to give us a sensible overview of the Australian Mining Industry.

Here's a recent video from Mathew going over the latest reporting season.

“When it's 30 plus degrees underground, a hundred percent humidity, the air is saturated and you breathe out, you like steam in the morning. You can have that underground when it's soaking hot, cuz the air can't take anymore anymore moisture.”

Mathew makes some interesting points around the demand for minerals in the future like lithium and copper, how long coal will be hanging around for, and whether there is anything that will compensate the big miners to the same extent as iron ore:

“Steel's not, it's not burned or used it hangs around. Right. It hangs around in cars, hangs around in buildings, hangs around in trucks and things. So at some point, those things reach the end of their useful life. And then they go back in the, the furnace again. Right. And recycled. Yeah. But instead of making, you know, steel from iron, or you make more steel from steel, at some point it becomes circular. Like the us is basically a circular economy is not a huge amount of new steel that gets made. So that's the future and recycling's big in Europe too. So that's the future for iron. So if you take away growth at the, the steel production level. So instead of having a doubling in the last 20 years, it's flat, and then you've got more scrap, okay. That equates to declining demand for iron ore right. That takes the price tension right out.”

TRANSCRIPT FOLLOWS AFTER THIS BRIEF MESSAGE

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EPISODE TRANSCRIPT

Chloe (2s):

Shares for Beginners.

Mathew (5s):

Is this an industry that will make money again? Will there be new demand for this commodity, such that at some point there need, there needs to be an incentive price. Will the incentive price be much higher than what it is now? And is that in the price, in the share price or not? Right? It's not in the share price. Things are cyclical. So when you see those kind of conditions, which is when I like to buy these things like very opportunistically, you might be early, right? The pain might last longer and longer than you expect. Right?

Phil (36s):

G'day. And welcome back to Shares for Beginners. I'm Phil Muscatello. And today we're just having a little bit of departure from normal programming in that we're gonna be looking at an overall sector, which is the mining sector. And joining me today is Mathew Hodge from Morningstar Australia. So welcome back to the podcast, Mathew,

Mathew (54s):

Thanks for having me.

Phil (55s):

So Mathew is the director of equity research Australia and New Zealand for Morningstar Australasia. But you've come from previously from a mining background where you've researched and analyzed the mining sector. Haven't

Mathew (1m 8s):

You? That's right. That's right. My original background was mining engineering, which it took me less than a year to figure out that wasn't my future. And from there, I've basically been involved in mostly mining stocks and basically covered mining stocks for 20 years now. Yeah.

Phil (1m 27s):

So how important is mining as a sector to Australia in the economy?

Mathew (1m 31s):

Yeah, so it's obviously our major exporter, right. And it's important for our currency and all sorts of things, right? Like a lot of our wealth comes from the, the wealth that's generated with mining and our purchasing power globally, you know, for investors. It's a really big part of the, the index Australia's index is really weird. It's roughly between resources and banks. That's about half of it. You compare that to say the US very, very different makeup of sectors. Right. So yeah,

Phil (1m 60s):

With much more technology in the US, obviously,

Mathew (2m 2s):

If you are a fund manager in Australia, you have to have a view, right. And, and in the us, it's just a few percent you can wholly ignore the sector.

Phil (2m 14s):

You just mentioned about how important it is for our purchasing power overseas. I remember during the global financial crisis that everyone was waiting for a calamity here in Australia. And in fact, our terms of trade were more stronger than at any other time in history. How, how does it help Australia itself from these global tidal forces?

Mathew (2m 39s):

Well, I, I think that that was a certain set of circumstances, right? Like, I guess Australia was less deep into the subprime rubbish, you know, there was a bit floating around like some of the banks had some of this stuff sitting on the balance sheet, which was utterly ridiculous. They should be just in the business of, of making home loans. Right? Yeah. Yeah. But what really helped out there was that China wanted to stimulate its own economy and we rode off the back of that. Right. So, so I wouldn't necessarily conclude that like mining is some stabilizing factor tends to be a very cyclical sector, but it just hap so happened that our major trading partner stimulated at that time and that drew a lot of demand for commodities that otherwise would not have been there.

Mathew (3m 28s):

Mm.

Phil (3m 29s):

So it's really changed, hasn't it? Because mining stocks have become a dividend stock as well or a dividend play. Whereas in the past they were never considered something that you'd be looking for dividends from.

Mathew (3m 40s):

Yeah. It's an interesting point. Right. So historically when commodity prices have been good, when cash flows and profits have been good mining, company's been wonderful at going out and spending all of that. Right. So like Rio Tinto in the decade ended 2015 had no net cash flow, right. So just every dollar it made plowed back in the ground. Right. And they blew up a lot of money. So that that's more of the history of, of the mining sector, right. They tend to invest when prices are high, they tend to make acquisitions when prices are high in the last, since 2015, when they got a big fright, when China turned down, they kind of found religion around, you know, having a strong balance sheet, which I think is really important when things are so, so cyclical and just returning cash to shareholders.

Mathew (4m 33s):

It's, it's harder to make a mistake when you do that. Right. I think the risk is that over the long term, you kind of don't pay enough attention to your growth opportunities. And you're kind of drawing down on that, right. But generally it's vastly preferable to some of the actions that have been undertaken by the sector in the past that said, this is not Telstra or a railway stock or a pipeline or a toll road, right? Like this not steady cash flows, right. It just is fortunate that demand really thanks to China. And basically China alone has been so strong for commodities, which has underpin high prices, which has given them the cash flows to give these fat dividends.

Mathew (5m 17s):

The fact that the dividends are so fat is also a function of the market. Doesn't think these, these kind of profit levels are gonna last. If they did, the, the prices will be higher and the yields will be less.

Phil (5m 28s):

So I really wanna start discussing what the size and the shape of the sector is. Now let's go right down to the tiny, tiny end, you know, we're, we often hear a little chip in a pub about this mining stock is gonna take off. What, what are those kind of companies and how should listeners view those kind of companies?

Mathew (5m 48s):

I remember, I think it was like 2006 or seven. And, and my mom recommended to me an exploration stock and I thought this market's pretty toppy. So I think that's the most use of the taxi driver tips is kind of like a gauge of how,

Phil (6m 8s):

How much hype there is around them.

Mathew (6m 9s):

Yeah. Like how, how high the market is. Right. So I, I tend to try to look for little milestones along the road and that, that would be one. So my inclination, it's sure it's interesting. I have the conversation, but my inclination from a conversation like that would be to come away and think, you know, things might be getting a bit too hyped, especially if you get a lot of people talking about shares and a lot of people interested in that, which definitely happens from time to time when the mining stocks.

Phil (6m 35s):

So what are those kind of companies like? I mean, are we talking about a guy with a shovel and a hole in the ground? Is that the kind of size we're looking at or a geologist taking some sort of samples? Well

Mathew (6m 45s):

It's, how does it work? It's, it's the whole range from, you know, someone's got some leases and an idea and they wanna raise some money and, and do some sampling. And that's typically how things start. They've got some targets. They want to test those targets. They raise some money and, and people will ultimately drill test those targets right at the very, very early stage. You know, that probably appeals to the innate sense of gambling that Australians seem to have. Most of these companies will fail. Very very few companies will ever find anything. And even fewer will actually go on to be, be a mine. The other thing that, you know, when people get really excited about these early stage companies, they don't realize like if they find something, generally we are talking like a decade and, and in between now, and then is a whole lot of capital expenditure.

Mathew (7m 38s):

That's an attribute that like, let's say, if you're a technology and you've got a SAS platform, it's already earning money and you're investing in it and you're growing right. Or a subscription business, people pay you up front. This thing has got this immense long period where you have to put money into it. You know? And I think I've recall reading about Mount ISA and it was decades before it actually started making money. You know? And that was, that was an amazing deposit.

Phil (8m 8s):

You mentioned gambling and yeah, the, the innate idea that this can be a bit of gambling because I have talked to another person who sort of talks about the old cowboy days and how there'd be a sniff of gold or a sniff of silver, let's put a few hundred thousand dollars in and just start exploring. And there is a bit of that mentality to this end of the market. Isn't there.

Mathew (8m 28s):

Yeah. And Warren buffet says, get rich slowly. Right. And this appeals to the opposite end of that. Right. But I think, you know, there there'll be a few people that will make money out of this, but I, I generally just don't think it's a, it's a wise strategy for people to engage in, unless you've just got a lot of money and you're very comfortable and you just really enjoy being part of that. Yeah. And you understand, you don't expect to make a return if that's your hobby and you can afford it. That's cool. But I think for ordinary people, this is probably not something that they should engage in and

Phil (9m 2s):

It's a bit of a gold rush mentality, isn't it? Yeah. It's, there is that, that's something in the human nature that's been around for a long time, I guess.

Mathew (9m 8s):

Well, it's, there's so many things that can go wrong with that. Yeah. With that level, you know, and it's, it's, it's a very specialized area and you need to cover a lot of ground. These companies gonna turn over pretty quickly. Right. So, yeah. It's not like, you know, Warren buffet buying Geico and then riding that for decades, you know, like those are the kind of investments. I really like the ones that can compound because you just sit on your bum and you don't do anything. You know, these things, you need to be very engaged and all over and watching and, and, and understanding, you know,

Phil (9m 40s):

So the mining sector, it's not just digging stuff out of the ground, which a lot of companies do. There's engineering services companies, there's also processes and so forth. Yeah. Am, have I missed anything in that workflow?

Mathew (9m 56s):

Like the, the contractors that do the actual mining as well, services that are provided, you know, technical services and consultants and stuff like that. But yeah, that the, I mean the actual mining companies are the bulk of the industry by market cap. And then there, there are some service providers as well. Yeah.

Phil (10m 16s):

Yeah. But they are quite high tech in a lot of ways. Aren't they? I mean, they are starting to use, you know, driverless vehicles and driverless trains and so forth and technologies that quite close to the cutting edge.

Mathew (10m 27s):

Yeah. So I think, you know, you're talking about like the Hitachis and, and caterpillars of the world when you get into that. And that's a, that's a whole different ballgame, right? Like that's a different business. Yeah. And fundamentally, some of those businesses are quite good. Right. Be, and, and particularly with the technology angle, you, you start to introduce, you know, an element of data and switching costs and efficiencies that the, the mining companies want, but those are obviously not listed here.

Phil (10m 56s):

So what's between these little speccy gold miners and BHP and Rio Tinto

Mathew (11m 1s):

In the middle bit. It can be really interesting. Right. So, you know, let's say a, company's got a decent project. Maybe they've got a feasibility study or they're going into a feasibility study. Those can be interesting because then you can start to wrap numbers around things and start to understand what something might be worth. Right. When you get to there, then you can actually, you move from speculation to more analysis, which is kind of starting to play into where I feel more comfortable. You can also have interesting things where you have, you know, certain management teams. I can think of like two where they've just, they've got a certain blueprint, they pick it up and they put it down. So I'm thinking of Tony Haggerty at Excel Coal.

Mathew (11m 44s):

He went from Excel Coal, he went to Whitehaven. Now they've got another vehicle, which I haven't followed yet, but, you know, my instinct would be something like that would be, be worth taking a look at, if not for the, the coal price being at 400 bucks or whatever that makes it more challenging. But there's some teams that actually they're more entrepreneurial, right? They've built their own wealth by doing this sort of thing. They invest their own money up front and they have technical skills and they've done it before. The kind of assumption that those guys need to make is we know how to navigate the approvals process and, and developing a, a mine. We also assume that this is cyclical. You know, it's a cyclical industry and we we'd like to invest and get into these things when there's not a lot of interest in them.

Mathew (12m 30s):

Right? So you get yourself a, a potential tailwind there and, you know, commodity prices at some point will be, will be better. And, and there's value uplift from taking something that's, you know, a dirt patch through to, you know, something that's making money. So I think that's where it's interesting, those opportunities don't come along very often, but it's worth paying attention when they do. The other example was, you know, the team that were at Eqigold and they went on to become another company. And now they've gone to do another thing. So there's a, there's a couple of, and that's in gold mining in west Australia.

Mathew (13m 12s):

That's their niche, Regis Resources. Yeah. So Equigold Regis Resources are now they're doing something else. Right. So there's two teams that I can think of what they've gone through. And they've done that multiple times and that can be worth following, but that's not typically what I would do. Those are the exceptions more than the rules. Right. So I guess when it comes to analyzing a project, I'd wanna know how big is it? Has it got potential to be scale? Is it good grade? Like how expensive is it to get to, like, you know, when BHP talked about, you know, doing a massive expansion in Olympic dam, I think they were talking about 20 billion to develop it. And there's, you know, years of, because it's hundreds of meters underground, like years of, of stripping just to get to the ore body.

Mathew (13m 59s):

Right. Like it would've been awesome when they got there, cuz the grade's really good, but it's just very expensive, you know? So ideally you want high grade massive close the surface, close to infrastructure, you know, so if you are in the middle of what, what you gotta get power and electricity and all of that's very, very expensive. It's getting easier to be kind of self-contained these days. And Ozminerals was looking at a project west Musgraves to do that. But those are the things that you want. Yeah. One

Phil (14m 27s):

Of the basics metrics I believe is AISC. Yeah. Can you explain what that is? Well,

Mathew (14m 32s):

It's just basically the total cost.

Phil (14m 34s):

Right. And what does it stand

Mathew (14m 35s):

For all in sustaining costs? Right. So

Phil (14m 39s):

I got you to say it because I would've inevitably got it wrong.

Mathew (14m 43s):

Well, this is typically something quoted by the gold miners, copper miners. The industry used to look at cash costs and the problem with cash costs. So it's like, well, cash costs are, what are the operating costs to get this bar of gold? Right? The problem with that is it ignored all the capital costs, right? And they're sustaining capital costs that you need to with a, with a mine that could include drilling, we need to drill further to extend the mine. Because at some point you need to do that. You need to maintain the, the plant and equipment. So things like that were overlooked, right? So it kind of superficially made the industry look more profitable than it was. And also if you had a mine that was more capital intensive than another, just by focusing on the operating costs, it didn't really tell you the true picture.

Mathew (15m 27s):

So the industry kind of decided to move to all in sustaining costs as a way of looking at things. Right. And ideally you want a miner that is towards the bottom of the cost curve. That's the point of that, right? So that's like, there's only one kind of competitive advantage you can have in mining. And that is being a low-cost provider. Right? Low cost means you have an over capitalized, right? So capital efficiency and operating cost efficiency.

Phil (15m 53s):

Okay. Let's move up the scale now to the big miners. So we're basically talking BHP, Rio Fortescue. Anyone else I'm missing out in that market cap?

Mathew (16m 3s):

Newcrest is probably the next one. It's a bit different gold miner. They behave a little bit differently. The three big ones that you've mentioned there are,

Phil (16m 10s):

They're huge. Aren't

Mathew (16m 12s):

They? Well, they are, they are big companies. They're big for this market, but they're also big globally, right? Like we are, Australia's a leader in mining globally, but they are, you know, mostly, I mean, in the case of Fortescue exclusively iron ore companies, right? So they have benefited greatly from steel production doubling in the last 20 years, all due to China, you know? So they've ridden that wave the iron price used to be 20 bucks. And now it's a hundred, which is vastly outstripped inflation in that period.

Phil (16m 43s):

I believe BHP. I'm not sure about the others were listed on multiple exchanges until only recently

Mathew (16m 48s):

They tend to have other listings as well. Like South Africa, London is the obvious one, right. New York, like these big companies tend to be listed in multiple places. And I think there's very decent liquidity in London and New York. And I'm not sure, so sure about some of the other listings that they have, but they are listed on a lot of exchanges. Yeah.

Phil (17m 10s):

So why is London an obvious place for a dual or multiple listing of a mining company? Yeah,

Mathew (17m 17s):

Well, I think historically it's been the financial capital of the world. Right. And it still has a strong center of gravity there, you know, so there's a big and deep pool of capital from Europe and in the UK that, that uses London as the financial hub.

Phil (17m 33s):

So there's a couple of forces acting here with our good fortune and the minerals and ores that we can extract from the earth in Australia. And that, especially now with ESG, we can be mining lithium at the same time as we're making so much money out of coal, which we thought a few years ago was gonna be a stranded asset.

Mathew (17m 53s):

Yeah. I think European energy policy has been shown to be somewhat flawed, relying on the, well, it's not the kindness of strange. The kindness of enemies, you know, has turned out to be not a great strategy. And if you think about, you know, Japan and Korea, they have always taken a very long term view in terms of energy security. And I think when you don't have very much in the way of your own energy, it really focuses the mind that seemed very old fashioned in the world that everything's just in time. And, you know, we try to drive cost down to the lowest number, but I can see that that idea is much more back in Vogue now. Right. And I think the Europeans are learning.

Mathew (18m 34s):

We need redundancy and we need other, you know, other sources of energy. And we just can't rely on a bad actor to provide so much of our energy needs.

Phil (18m 44s):

Another commodity that we have a lot of in Australia is uranium. Yeah. What are your views on uranium in a nuclear future?

Mathew (18m 51s):

Well, if the globe is serious about reducing carbon emissions, it seems like the obvious answer, there is a need for, for base load power and you can do that with nuclear, right. We had a period where we just didn't have new nuclear plants being built. And I think there's a bit of a Renaissance going on now. It ships very easily. It's, it's a huge amount of energy in a very small place. So I remember doing the, the calculations as going back a long time, maybe like 15 plus years ago. Yeah. And, and the amount of uranium that comes out of Olympic dam for BHP in terms of energy, I think it was, it was either at least as much or more than the whole of its oil and gas division.

Mathew (19m 36s):

Right. So, and, and for that, they earned very little, you know, in the hundreds of millions of dollars, like just like a rounding error for, for BHP. So the, there is immense energy in uranium in a very small footprint. And I think that has appeal. And also like when you think about shipping costs, like moving stuff around the world, it moves pretty easily because it's just so much density of energy that the transport costs is just very, very small as a proportion. So like for Europe, which is a long way away from, you know, from energy production, other than Russia, that could be part of the solution and a country like France is coming out, looking pretty good, you know, because they had that old school, you know, mentality of, we need to make sure that we can look after ourselves and not have too many interdependencies.

Phil (20m 25s):

So what do you see as the future of coal?

Mathew (20m 29s):

I think, you know, there's a few scenarios, right. But I mean, it's, it's inevitably going to decline. I think the decline will probably take longer than people expect, because if anything goes wrong, it's probably their easiest option just to keep something open for longer. But it, it really depends which declines fastest. Right. Is it demand that drops off fastest or is it supply right. And I think it's, it's hard to get new supply going. You could have a situation where the demand hangs around for a bit longer than people think and supply just isn't there. So you could have a period of high prices for coal for a long period of time, right?

Mathew (21m 9s):

Like this is a bit of analogy with cigarettes, you know, it's not exactly the same. Right. But when the cigarette companies couldn't advertise anymore, their biggest expense just dropped off. Right. And also they were no longer competing for each others' customers. So they just had these immense cash flows. Right. Even though the product was in decline, I mean, you, you never saw an IPO for a new cigarette company, right. Like there's no one wants to compete in a sector that's going down. Right. And that can, that can mean amazing profits, you know, the great

Phil (21m 41s):

Dividend

Mathew (21m 41s):

As well. But the, the, the thing with the coal miners is if, if they're not building new mines anymore and

Phil (21m 48s):

There hasn't been any investment in new mining has, has

Mathew (21m 51s):

There, well, there's a, there's a bit, there's still, you know, new minds coming here and there, or extensions of minds cuz things come to an end. So if we weren't doing at least that the whole thing would be going backwards already. Right? Yeah. So, you know, building new mines is one of their biggest expenses over the life cycle of a coal mining company. Right. So if you take that away and it's just in harvest mode, I mean, there could be amazing cash flows coming from these things. Right? So like I'm, I'm not saying that the kind of money that they're making now is gonna hang around because like, you know, thermal coal at $400 is just, you know, back in the day, a hundred dollars used to be a fantastic price. So like 400 is, is off the charts.

Mathew (22m 32s):

But by that, that same token, the market's not expecting these prices to hang around very long either.

 

Phil (22m 39s):

What about lithium? It's, it's a very interesting part of, I mean, they they're like coal prices at the moment. Lithium prices is buoying the lithium miners at the moment.

 

Mathew (22m 48s):

Yeah. So that's, that's a sector that's definitely growing and it does help you when you have growing demand. Right. So I contrast that with iron ore going forward, I think it's gonna be very difficult for iron ore demand to grow. And that's gonna mean that the next kind of 10, 20 years gonna look very different from the 10, 20 years of high growth that we've had when you have growth in a commodity. So there's the stay in business price, right? If demand is going down at a decent clip, then it becomes race to the bottom. Only the lowest cost providers can stay in the industry. Right? Yeah. And all you need to do is get paid enough to stay in business. All that money is spent on capital. You are not owed to return on that, right.

 

Mathew (23m 29s):

If a market's growing, the price needs to be high enough to incentivize new supply. So at different benchmark, the stay business price, when you've got a flat or declining demand profile versus the market is asking these companies to add more supply, here's the price we need to do that. Right. So, and, and lithium has had fits and starts, right? Like there've been periods where it's been in over supply, but those periods haven't lasted very long and then they've returned to, to undersupply, you know, or, or excess demand. So that can be very interesting too. And, and the behavior of the miners kind of matters here as well. I mean, Glencore is a very interesting one. They're not in the, the lithium space space and this is tangential, but I'm familiar with the way they behave.

 

Mathew (24m 14s):

Right. So there's been times when the zinc market's been oversupplied, there've been times when the thermal coal market has been oversupplied,

 

Phil (24m 20s):

Then this is an aspect of commod commodities aren't they that's just to do with the price of commodities.

 

Mathew (24m 25s):

Yeah.

 

Phil (24m 26s):

And this is really what mining is based on.

 

Mathew (24m 28s):

So if, if demand drops a few percent, right? Like the price is very different, right. You know, the price could be down 50% on small changes in demand, right? Because the price is set at the margin at those times, Glen cost said, well, we're just not gonna operate these mines at this price. You know? And we're just gonna take out some supply. It happened with cobalt as well. When you have behavior like that, you can have periods where, okay. Prices are not very good for a certain commodity, but you can say, okay, well I think the suppliers are going to be disciplined. I can see that this is a cyclical phenomenon. Those can be really good times to invest in these companies when you're looking around and the industry's not making money.

 

Mathew (25m 10s):

All you need to do is, is, think about, well, is this an industry that will make money again? Will there be new demand for this commodity, such that at some point they need, there needs to be an incentive price. Will the incentive price be much higher than what it is now? And is that in the price, in the share price or not? Right. If it's not in the share price, you got a pretty good chance of making money. Right. You know, and things are, so things are cyclical. So when you see that, those kind of conditions, which is when I like to buy these things like very opportunistically, you might be early, right? The pain might last longer and longer than you expect.

 

Mathew (25m 49s):

Right. But, you know, I think something like white Haven coal was a good example. The whole coal industry, wasn't making money in 2020 with COVID and now, you know, that there was no new supply, right. The supply taken out, demand, rushed back, and now they're making money, hand over fist. Right. That's, that's an extreme example of, of the kind of thing I'm talking about. But when you have those conditions where things are so beaten down, that's when I think the sector's interesting,

 

Phil (26m 17s):

There are some places on the planet where mining takes place without the kind of oh. And S oversight that we have here in Australia. Yeah. And the human rights, basic human rights that we treasure and trust in Australia. Yep. I dunno, because mining just does get a bad rap sometimes in terms of ethics and so forth. But

 

Mathew (26m 36s):

Yeah.

 

Phil (26m 37s):

What, what are your thoughts on that?

 

Mathew (26m 38s):

Well, I think, you know, if we're kind of puritanical at home and like, okay, we don't want to build anything here. It's like, it, it kind of ignores okay. The amount of wealth that comes from this. Right. So it's a land use question, right? I think no one questions agriculture as a land use. But if you think about how the landscape has been transformed as a function of agriculture, it is an immense footprint, global it's large, isn't it? It is huge, right. Mining time mining is, and people, people lose perspective on that and the amount of wealth that comes from it. Right. And the classic, I see people driving around with stickers on, I saw one on a big four wheel drive that said no oil.

 

Mathew (27m 21s):

I'm like, you've gotta be kidding. Right. Like, like where's some consistency here. Right. So I find it amusing when certain funds will screen out BHP and then JB high-fi is cool to own. Right. Like where's all the stuff coming from, you know? So I think sometimes that kind of ESG lens can be overly simplistic. And if we are not mining it here, right. It's gonna get mine somewhere else. Right. And if your concerns are global, right. It would make sense that you want mining to occur in the jurisdiction where it's gonna be best practice.

 

Phil (27m 57s):

I was just reading an article about royalties in mining companies. And we, we know about royalties with copyright and music, but yeah. Royalties are, have become, or they have been and are becoming even more. So a big part of the cash flow of mining companies.

 

Mathew (28m 14s):

Well, the, for mining companies, it's a cash outflow, you know, except for, you know, like Deterra is a royalty company, which is, which is rare. There's a few little things like that.

 

Phil (28m 24s):

No, just in, in the article I said that I saw, they were mentioning that Rio had actually discovered some royalty streams, which they were able to package up and sell off. But yeah, I might be misinformed

 

Mathew (28m 34s):

On this. No, no, that's, that's true. But they're very small beer in terms of

 

Phil (28m 38s):

They're the rounding areas again,

 

Mathew (28m 40s):

Are they? Yeah, yeah, yeah. But, but so how those come about is some of these deals, when we talk about going back to the really, really small companies, you know, like, like an asset might get sold and someone retains like a 2% royalty or something like that. Right. That would be a typical thing. Right. And usually the, the project never comes to fruition. The royalty's not worth anything, but occasionally it does. Right. And you know, I think Iluka had the mining area, sea royalty on its books for three or four decades, a long time. Right. And you know, now that thing is generating just, you know, more than a hundred million and, and the thing with when they're spotted off into Deira.

 

Mathew (29m 24s):

Right. But the thing with Deira is I think that's probably the highest quality company on the ASX because it doesn't have any operating costs. It doesn't have capital costs. The biggest risk with Deira is if they go out and buy something else and pay too much. Right. But otherwise, so

 

Phil (29m 41s):

Do they just gather royalties? Do they yeah.

 

Mathew (29m 44s):

Cashing, royalties. That's what they do. So mining area C, which is, which is BHPs, it's one of their really, really big areas and they're expanding it and they get a, they get a royalty off that, but it's basically like a, it's got more in common with a toll road than a mining company. The only difference being that price that the toll road can charge fluctuates based on the, based on the price, you know? No, no, not, not usage cuz the, the volumes are pretty constant. Right. Although they are growing, right. The volumes are much more stable and say traffic would be right. But the price varies just based on the international price for iron all. But something like that is, it's not exactly passive, but it's more like, you know, more like that.

 

Mathew (30m 28s):

Yeah.

 

Phil (30m 28s):

Well just to finish off, what was it about the mining industry that first attracted you when you were a, a young guy with a hard hat in a Fluro vest that's

 

Mathew (30m 36s):

A long time ago and I've learnt much since then the theory was, you know, I grew up in the country. So I liked, I liked the idea of a job where I took my brains and could apply that, but also in a practical sense, right. In a tangible sense. So I think the, the reality that I found in the industry was it it's a hard industry. Right. You know, depending where you go. And I had, my brother spent, you know, the zeros building, you know, plants in Karratha and stuff like that. It's like that that's a very, very hard life I've and the nuts and bolts of engineering.

 

Mathew (31m 17s):

It's very, very fine attention to detail. Right. And I figured out in myself that I like to see things from a higher, broader point of view and I've got much wider interest. And in that sense, I think, you know, being a stock market analyst keeps me much more, more interested.

 

Phil (31m 33s):

You can wear cleaner clothes as well.

 

Mathew (31m 36s):

I didn't mind that so much, you know? Yeah, yeah. That, that didn't bother me. But you know, when, when it's 30 plus degrees underground, a hundred percent humidity, the air is saturated and you breathe out, you like steam in the morning. You can have that underground when it's soaking hot, cuz it, the, the, the, the air can't take anymore anymore moisture.

 

Phil (31m 57s):

And hasn't there been a, a nexus between the agricultural community and the mining community. A lot of times when times are tough for, for farmers that they can go and work in the mining industry.

 

Mathew (32m 7s):

Well, that was true in my town too. They had a mine there that was built in the nineties and, you know, I could see the wealth and opportunity that, that bought and that was appealing. You know? So mining is an industry where you can, you know, travel far and wide if, if you so desire. And there's a lot of, there's a lot of wealth that comes from that, but it's a hard job too, you know?

 

Phil (32m 32s):

Okay. I think that's all, unless there's anything else you wanted to say about the mining industry?

 

Mathew (32m 35s):

Yeah. People think they need to own these things, perhaps they don't, you know,

 

Phil (32m 41s):

What shares in particular companies

 

Mathew (32m 44s):

Or, oh, like, like, oh, you know, like no one ever got fired for, you know, for hiring IBM, you know, like I'm not gonna get fired if I own BHP or no, one's gonna criticize my portfolio. I BHP it's like,

 

Phil (32m 59s):

But I mean, look, you look at the price action of BHP. I mean, what is it at the moment? I don't know. Is it $36 somewhere

 

Mathew (33m 6s):

Around then? It's probably, I don't know. I don't, it's been a little while since I,

 

Phil (33m 8s):

No, no. Yeah. It's but I mean, it's only ever been as high as 50 something, I think at the very highest possibly. So in terms of the price action itself.

 

Mathew (33m 20s):

Yeah.

 

Phil (33m 21s):

It's it hasn't been a great performer.

 

Mathew (33m 23s):

No, but a lot of the return has come from dividends as well. So perhaps, you know, normally mining companies are capital return businesses, like, so, so capital appreciation businesses, I should say so that you would expect the majority of the return to come from growth in the share price. Right. How's that coming? It's coming from growth in the profits. And then much of that profit is then being reinvested back into the ground into new mines. Right. And yeah, we've had this period of, you know, five plus years where that really hasn't been the case where they just returned cash to shareholders by and large, but that can't go on forever.

 

Phil (34m 0s):

Yeah. And there's been some disastrous acquisitions as well, and which has held them back over the

 

Mathew (34m 5s):

Years. If you go back, you know, and there were some that they looked at, which didn't go through and if they had it, would've been even more disastrous, you know? So, you know, sometimes they've been lucky to miss out on some of their plans, not coming to fruition, but, you know, by and large, the industry has been very disciplined. I think for the mining companies for the big mining companies are so reliant on iron ore outside of Glencore, but BHP, Rio Fortescue, I think iron ore they must be looking at how much earnings have come from iron ore and going, how do we fill that? Right. And I think that's part of the motivation to take over something like Ozminerals, those miners want to have forward facing commodities, you know, commodities that are likely to benefit from green energy.

 

Mathew (34m 50s):

And I think that's part of the motivation, but the risk here is that you have likely materially declining earnings from Iron ore..

 

Phil (34m 58s):

Why, why is that? Why is it declining? Well,

 

Mathew (35m 1s):

The, the process just very, very high returns are very high, right? People get used to a hundred dollars in, or, and they think, oh, you know, the prices dropped from 150 to a hundred. These things are cheap now, but the industry's still making phenomenal returns when you stand back and you look at how much money has been invested in these assets and what kind of, you know, returns they're getting from those they're still amazingly high, right? Like the price can fall a long way before you have much of an impact on supply. The iron cost curve is pretty flat, so you can have materially declining iron earnings. And I guess part of your question there is why is that gonna have, well, I, China can't take anymore steel. I don't think, right. Like, they've just had this, this debt binge, the debt's been building up, that's been directed into infrastructure and houses.

 

Mathew (35m 49s):

The peak of urbanization has passed. Yet they've kept on investing more, right. At some point they've over capitalized. I think we've reached that point probably five plus years ago, but they've persisted. Right. And with the fallout from what's happening with the property developers in China, I think that's part of the rot. Right. You know, so I think that's a, what happened this time last year, I think, is meaningful with, you know, China, evergreen. So I think that's potentially the turning point. We might look back on that and say, that's a turning point. And this is the first year we've had, we've had imports from China, be down materially. Right. And is it a trend? Right. And it, you know, one year doesn't doesn't mean too much, but if it, you know, next year's down and the year after that's down, I mean, I think then you start to see a trend.

 

Mathew (36m 33s):

Right. And the other thing is, is they've got, they've got this huge amount of, steel's not, it's not burned or used it hangs around. Right. It hangs around in cars, hangs around in buildings, hangs around in trucks and things. So at some point, those things reach the end of their useful life. And then they go back in the, the furnace again. Right. And recycled. Yeah. But instead of making, you know, steel from iron, or you make more steel from steel, at some point it becomes circular. Like the us is basically a circular economy is not a huge amount of new steel that gets made. And that's,

 

Phil (37m 7s):

Well, really, I never, never

 

Mathew (37m 9s):

Realized that no, mostly recycled. So that's the future and recycling's big in Europe too. So that's the future for iron. So if you take away growth at the, the steel production level. So instead of having a doubling in the last 20 years, it's flat, and then you've got more scrap, okay. That equates to declining demand for iron ore right. That takes the price tension right out. You don't need the incentive price anymore. We've had incentive prices in Inor for the last 15 plus 20 years, and that's underpinned amazing returns for that business. So if those conditions go away and I think that's, what's likely, then these big miners are looking at a gaping hole to fill in their earnings.

 

Mathew (37m 51s):

Right. And copper is part of it, but it's just not big enough. You know, the sheer size of the profit pool in iron ore copper is not gonna be big enough to fill the hole,

 

Phil (38m 3s):

Even though it's gonna become much more expensive in the future. By presumably if it's, we're all gonna be driving EVs and much more electrification.

 

Mathew (38m 10s):

Yeah. Some of the work that we've done suggest that the OEMs, so like the BMWs with the world, right. So the, the car manufacturers, they will be, re-engineering the architecture of electric cars such that they'll use a similar or perhaps even a little bit less copper than a conventional car. Right. And the SEP the separation of the electricity part from the control. Cause at the moment it's all one, right? So the wires carry both electricity and signal. Yeah. So you separate those two out and you have two separate systems and the amount of copper that you need halves. So there's always been in mining, this tension between technology and efficiency, which drives you to use less and less versus overall increase in demand.

 

Mathew (38m 58s):

Right? So we think the odds actually are that people are overestimating how important the EV story is gonna be to copper. And the other thing, when you see these bullish demand forecast for copper is China is the big piece, right? It's way more than half and copper looks similar to iron iron ore in terms of demand. Right? So it goes into housing, you know, copper pipe and, and wiring. And it goes into infrastructure. You know, it goes into power cables and things like that. So it, there, there is some consumption, but a lot of the drivers are investment, which is actually quite similar to IOR more similar than what people think.

 

Mathew (39m 42s):

So Interesting. Yeah.

 

Phil (39m 45s):

Matthew Hodge. Thanks very much for joining me today.

 

Mathew (39m 48s):

Pleasure.

 

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