THE last time Exxaro Resources publicised a shift in strategy it provided so little detail that investors heavily sold the firm’s shares. That was in 2018 when CEO Mxolisi Mgojo articulated plans to move into food and water security – a major change for one of South Africa’s largest coal producers.
The company later clarified that the strategy would be backed by modest investments, but the damage was done. In any event, Mgojo remembered the criticism he received. He subsequently said further pronouncements on strategic direction would only be disclosed when fully fleshed out.
That day arrived on September 20. During a ‘capital markets’ presentation (that the press was prohibited from attending live), Exxaro CEO-designate Nombasa Tsengwa said the group would target acquisitions in bauxite, manganese and copper, potentially involving ‘lumpy’ (big capex) investments.
This time around, Exxaro was so pinpoint in its ambition that it earmarked Guinea and South America as potential markets for new bauxite investment while manganese assets would be targeted “on our doorstep”.
It was slightly less clear regarding copper although it explained ‘tier 2’ assets would be targeted given the metal is much coveted by larger, more deeply capitalised businesses such as Rio Tinto and BHP.
In respect of merger and acquisition activity generally, Exxaro would target deals where there was cash flow or projects nearing production.
The plan is pretty gutsy. For a high cost of capital coal producer worth R62bn to enter an M&A market involving hard currency earners Rio Tinto (worth £77.6bn) and BHP (£98.2bn) is a massive display of self confidence.
Tsengwa said Exxaro had the bulk mining skills to compete given its coal production and has learned from past missteps. A R5.3bn write-down on the Republic of Congo iron ore prospect Mayoko in 2014 had resulted in strengthened governance, she said. It would introduce greater independence in due diligence.
Derring-do instead of dividends
Implicit in the end-game for Exxaro is to lessen its reliance on coal production.
According to Tsengwa, the new minerals business could represent 50% of expected coal EBITDA (earnings before interest, tax, depreciation and amortisation) within 10 years. In addition to new minerals production, the company also wants to become a major force in independent power production.
The merit in the strategy is recognising the firm’s prospects turn on unloved coal and a one-fifth stake in Sishen Iron Ore Company. This stake, held with Kumba Iron Ore, has served the company well in the past but – as evidenced in the past month – the iron ore market is mightily volatile.
However, the new strategy is also filled with uncertainties. Exxaro wants to develop a business in IPP, but that turns on unarticulated wheeling agreements with Government. In addition, stepping into global M&A is not for the faint-hearted.
Consequently, analysts are wary of the departure. “I guess transition is best for the company long term, but the other choice is pay lots of dividends and die with coal in 30 years,” said one analyst. “It’s not great news for investors, dividends would be better.”
Exxaro’s financial director, Riaan Koppeschaar said during the capital markets presentation that it wasn’t the firm’s intention to “… hoard cash for the next nine or 10 years … We would look to deploy surplus cash”.
Cost of compliance
The strategy also has elements of reactivity; that is, it’s in the context of ESG compliance pressure.
Writing in an August 24 note, Nedbank Securities analyst, Arnold van Graan observed that CO2 abatement strategies, although potentially costly for mining companies, are existentially inevitable.
Citing a 2019 report by the Institute for Energy Economics and Financial Analysis, more than 100 global financial institutions have developed increasingly tight divestment or exclusion policies around thermal coal, he said. This includes 40% of the top 40 global banks, and 20 globally significant insurers.
Bearing in mind that Van Graan’s report exclusively refers to South African gold and platinum group metal companies, he concludes that: “… [W]hat is clear is that CO2 abatement has become a business imperative. Not only could it impact the bottom line, but is has started to impact the investment case of companies we cover”.