Copper's road to a super cycle

Copper demand is poised to increase over the next decade. Despite facing challenges in traditional cyclical sectors like construction, manufacturing, and appliances, copper demand should remain resilient, driven by an overriding trend: the global energy transition.

The growing global adoption of renewables, grid expansion, and electric vehicles (EVs) is serving as a powerful counterbalance to the weaknesses expected in traditional copper-consuming industries (like construction).

Figure 1: Copper price has fallen back after cyclical weakness but remains elevated

Electrification will more than offset China property contraction

China, a key player in the copper market, is undergoing a notable shift in its once dominant construction sector, which significantly drove copper demand in the past.

A bear case for copper has been that a contraction in household formation in China would offset the demand for copper from electrification.

However, China's construction sector now accounts for only about 7% of global copper demand, while the global demand share from EVs and renewables has surged to ~13% in 2023, with growth exceeding 20% per annum. By 2030, the energy transition share of copper demand is expected to be ~22%. We see upside to these estimates.

What drives the substantial need for copper in the energy transition?

Longer term, the energy transition will underpin significant structural growth in demand for copper as significant quantities of the metal will be needed to modernise electrical grids and energy infrastructure, to build new solar and wind energy generation capacity, and to manufacture a growing fleet of electric vehicles (EVs).

Figure 2: 2.4x more copper is used in EVs vs conventional ICE vehicles; this will drive higher demand f or copper as the world shifts to EVs

Figure 3: An offshore wind plant requires 7x more copper than a gas-fired plant; this will drive higher demand for copper as the world shifts to renewables

EVs typically require around 3x more copper than comparable conventional internal combustion engine (ICE) vehicles.

Solar and offshore wind require an estimated 3x and 7x more copper, respectively, per megawatt of installed capacity than typical fossil fuel energy sources. Therefore, copper production will need to significantly increase to achieve ‘Net Zero’.

Supply falling short of meeting the significantly increased demand

Growth in copper demand is expected to outpace new supply over the medium to longer term. This is due to:

Long lead times for new mines: Developing a copper mine is a complex and time-consuming process. It involves exploration, permitting, construction, and commissioning, which can take several years to complete. According to the International Energy Agency (IEA), lead times average 17 years from discovery to production.

Declining ore grades: The average grade of copper ores has been declining over the years, meaning that miners need to process more ore to extract the same amount of copper. This not only increases operational costs but also requires additional energy and resources, which may not be economically viable at current copper prices. This should shift the incentive price for copper higher, increasing the long-term price.

Given the favourable supply-demand dynamic, we are structurally bullish on the copper price.

Figure 4: The long lead times of copper raise questions about the ability of supply to ramp up output if demand were to pick up rapidly

Figure 5: Copper ore grades are falling

Adding Sandfire Resources (ASX: SFR)

SFR is one of the only ‘pureplay’ copper miners on the ASX, providing the highest quality exposure to the commodity, in our view. The company operates two high quality assets: MATSA in Spain, which currently accounts for the majority of SFR’s production; and Motheo in Botswana, which is in the early stages of ramp-up.

We are attracted to SFR for the following reasons:

• Strong production growth - SFR’s total copper equivalent production is expected to increase from ~130kt in FY23 to >150kt in FY25, driven by the ramp-up in production at its Motheo asset. The delivery of Motheo has been first-class, with the project delivered on-time and on-budget thus far - an impressive feat amidst an inflationary backdrop for project construction globally. Motheo’s ramp up will drive significant earnings growth over the coming years that is not reliant on upgrades to long-term consensus copper price assumptions. Wilsons Research forecasts a 3-year EBITDA (earnings before interest, tax, depreciation and amortisation) CAGR (compound annual growth rate) of ~25% for SFR.
• Impressive cash flow profile - SFR is projected to deliver an attractive free cash flow (FCF) yield of ~18% in FY25 as Motheo ramps up towards its ultimate output. This is roughly double the FCF yield of its pureplay copper peers globally. We expect the market to look forward to this soon, which could drive a re-rate in SFR’s valuation.
• Underappreciated MATSA optionality offers valuation upside - While MATSA has ~6-7 years of reserves at current production rates, which may be a concern for some investors, we are confident that SFR can materially add to its existing reserve life. Wilsons Research’s base case assumptions include 30 years of mine life at MATSA given: (1) the geological potential within the Iberian Pyrite Belt underpinning its exploration potential, (2) MASTA’s track record of resource additions and the asset’s history of resource to reserve conversion, and (3) the potential for regional cooperation/consolidation. As MATSA’s mine life is extended, we expect SFR’s net present value (NPV) valuation to re-rate higher (potentially >A$10 per share).
• Robust balance sheet - As cash flow builds, SFR is likely to swiftly deleverage its balance sheet. Net debt-to-EBITDA is expected to sit at just 0.2x in FY25, and by FY26, Wilsons Research forecasts SFR will have Net Cash of ~$180m on its balance sheet. This provides ample flexibility to fund Motheo’s ramp up, as well as further additions to MATSA’s reserve life, regional consolidation opportunities, and other exploration activities.
• Takeover potential - Given the scarcity of listed pureplay copper miners, both domestically and globally, and considering the significant role the commodity will play in the energy transition, we see SFR as a potential takeover target (likely once Motheo is fully de-risked and at its ultimate output). The major diversified miners have already demonstrated their intentions to diversify into ‘future facing’ metals like copper.

Figure 6: Copper equivalent production (kt) will increase materially with the ramp up of Motheo

Figure 7: Production growth will drive rapid EBITDA expansion over the medium term

Figure 8: Gearing is likely to swifty decline with net cash expected by FY26

Figure 9: The market does not appear to be pricing in SFR's superior cash flow growth vs global peers

Trimming BHP (ASX: BHP) 

BHP has outperformed the ASX 300 over the last 1/3/6 months amidst resilient iron ore prices, which provides a good opportunity to take proceeds from the company to re-allocate elsewhere.

A key appeal of BHP (compared to the other majors) is its growing exposure to copper, although as a ‘pureplay’ miner, SFR provides more direct exposure to the commodity, which is attractive considering the favourable structural outlook over the medium to long term.

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