Written by ALWYN VAN DER MERWE & SHIRAAZ ABDULLAH
There are two aspects of the new mining charter which will directly affect our valuation of companies in this sector:
- An increase in BEE ownership of mining companies from 26% to 30%. The principle of ‘once empowered, always empowered’ apparently doesn’t apply – previous transactions won’t count towards a company’s empowerment credentials. In our view, this will open the door to continuous dilution of existing shareholders (since an increasing number of shares will be granted to BEE shareholders). This all has to happen within a period of 12 months, which will negatively affect mining companies’ share price.
- A 1% turnover tax for community development. This essentially means BEE shareholders will acquire a portion of the revenue before expenses or interest payments. From an investment perspective, this will negatively impact the value of the mining companies concerned.
There are several other aspects of the mining charter which are also likely to stymie investment in the sector:
- Prospecting rights will only be granted to companies which are majority black-owned. We believe we should be encouraging prospecting by anyone willing to take the risk.
- The 30% BEE stake has to be held in prescriptive proportions: 14% BEE entrepreneurs, 8% employee share ownership and 8% community. This will be difficult to implement on a practical level, as previous schemes will vest at different times.
- BEE shareholders can control the marketing and transport of their production stake. In our view, this will be challenging on a practical level, since mining companies may already have sales agreements in place for all production.
- Preferential options will be granted to BEE companies to purchase mining assets that come on the market. Since the Department of Mineral Resources controls the transfer of mining licenses, this can lead to companies accepting larger discounts on asset sales.
SHIFTING GOALPOSTS
In our view, the biggest challenge the new mining charter presents from an investment perspective is the fact that the goalposts are constantly shifting. BEE ownership has now jumped from 26% to 30% – how do we know this won’t change to 40% in future? The charter seems to be fairly prescriptive in some areas, but vague in others. There appears to be a lack of understanding of the economics of the industry and the current challenges of underinvestment and job losses. The absence of any collaboration with the private sector is also of grave concern.
The importance of the new mining charter should in our view not be downplayed – its impact may well spill over into the banking and other sectors supporting the mining industry, such as chemicals, explosives, steel, and mining equipment importers. Indirectly, if misinformed government departments are used to sway votes in the ANC’s leadership elections later this year, other sectors may also be at risk and subject to similar poor pieces of legislation.
WHAT WILL HAPPEN NOW?
The Chamber of Mines, which represents 90% of South African mining by value, has stated that transformation of the industry needs to be done in a sustainable manner. The charter has paid no heed to this, and the chamber has indicated that it will seek an interdict to suspend its implementation, taking the matter all the way to the Constitutional Court if necessary.
If a negotiated settlement is reached with the Department of Mineral Resources, it is likely to take the form of previous iterations of the mining charter. We don’t believe the charter will be implemented in its current form – it could very well destroy an already frail industry.
WHICH SHARES ARE LIKELY TO BE AFFECTED?
The proposals in the new charter have unfortunately had an impact on the performance of the local equity portfolios of SPW clients. We argued earlier this year that we still see substantial value in diversified miners Anglo American and BHP Billiton, even using conservative assumptions. We also hold Sasol and Mondi in our client portfolios, but we have no exposure to platinum or gold mining companies.
In its current form, the mining charter will impact Anglo American through its stake in Kumba Iron Ore and South 32’s South African coal assets. Sasol’s coal assets will be marginally affected. We don’t expect BHP Billiton to be impacted at all.
We maintain our view that despite the new proposals, the value in both Anglo American and BHP Billiton is still evident. Simply based on value, we won’t be selling at these prices. However, while the uncertainty and the potentially negative implications of the proposed charter provide the backdrop to investments in the sector, it would be naïve to expect strong performance by Anglo American in particular. Investors will naturally demand a higher premium for an investment where the risks are higher, which implies that these shares are unlikely to re-rate, despite our views on valuation.
From a broader portfolio perspective, we are concerned about what appears to be highly reactive policy formulation against the background of so-called ‘radical economic transformation’. We therefore still maintain a healthy exposure to rand-hedge counters in our local equity portfolios.
