Was your recent C$85million Western Potash Corp financing deal, motivated by Russia’s invasion of Ukraine?
Michael W Scherb: We have been looking for potash exposure for our investors for some time. We like the fundamentals of changing food consumption patterns in emerging markets, which will put greater demand on fertiliser. We determined that lots of potash supply is high capital intensity and infrastructure linked so we were delighted to find a project that was almost through ramp up and just needed completion capital, and therefore made this investment via structured credit. 40% of the world’s potash supply comes from Belarus and Russia so it allows our investors to get exposure to agriculture but also hedge against food price inflation, which is clearly a major social dynamic that is happening globally.
Do the current geopolitical tensions create a premium for projects in secure jurisdictions?
MWS: There has always been a premium on the sales side. On the flip-side, we expect a reverse premium for investing in emerging markets as our required returns need to be slightly higher for Latin American projects and higher again for African ones. The social theme driving some of the emerging market angst now, is near-shoring and that’s not just driven by war but also by Covid-19. We have seen it across all industries, where security of supply became extremely important for operation and continuity in a crisis. People are paying higher premiums for developed markets when they acquire projects.
But against that you have the trend of the last few decades where investors move into emerging markets because much of the lowest fruit has already been picked in developed markets. Investors and companies want security but in mining you also need supply, which means you must have a strong presence in Latin America. You can’t just focus on Canada and Australia if you want to be a global investor and offer outsized returns.
We have now grown to have offices in seven different jurisdictions, with 5,000 people working with us. Almost two-thirds of our investments have been in Latin America, because we find the risk reward balance attractive. Every country in the region is different but select jurisdictions, such as Mexico and Brazil are very attractive relative to Australia or North America, where permitting is challenging and there is excessive NGO risk.
Western governments want electric vehicle supply chains; will that lead to faster mine permitting?
MWS: Greenflation is a serious risk for the sector and it is actually driving a lot of the inflation we are experiencing. We are in active discussion with governments on critical mineral policy. We have hired Frank Fannon, who was US Secretary of State for Critical Minerals. The factors we have already mentioned mean that there is now a willingness by governments to understand the reality of certain minerals. It has moved from white papers being written to action being taken. However, there is no coherent policy yet. It needs a well thought out plan with offtake and financing all considered. For example, if a project secures an offtake that sees the minerals going to a country that already controls 70% of the global market in order to process it, then it doesn’t solve your strategic issues.
When it comes to the energy transition, we realise that it is easy for politicians to make ambitious long-term pledges that they won’t be accountable for. I think there is a growing realisation that the critical pinch point for the energy transition is upstream. It is also clear that we need to reduce greenflation, with some policies pandering to parts of the population that don’t want mining at all. Environmental blockages prevent projects that can fight climate change, but of course there needs to be a balance with miners building and operating in a responsible manner. Governments are reacting to inflationary pressures with fiscal policy but the best way to ease inflation is to allow mines to come online so that the cost of all consumer products around the world falls. At the moment governments are doing the opposite.
The energy transition requires intense investment in metals mining; will that encourage new forms of finance?
Since Appian was founded in 2015, we have made 17 investments and built seven operations into production out of our nine equity investments, with the rest being credit or stand-alone royalty investments. We have also exited nine investments, so our model has been proven successful. It can best be described as long-term value investing with a technical arbitrage slant. But despite our success the model hasn’t been replicated, which implies the barriers to entry are very high.
You have seen shorter-term capital move into the space but mining valuations are not responding just yet. Mining companies trade on a 15.4% free cashflow yield. Compare that to a prominent EV manufacturer that trades on a 0.5% FCF yield or renewable energy companies that also have a 0.5% FCF yield. Indeed, your average EV battery company trades at a FCF yield of minus 0.6%. The mining sector is making the most money from the energy transition but mining still isn’t attracting sufficient capital for some reason. There is an EV manufacturer that trades at 80 times Ebitda, while EV battery companies trade at 40 times Ebitda and renewable companies at 14 times Ebitda. Yet the major mining companies trade at just four times Ebitda. Something is off somewhere for our sector.
At Appian we have a good finger on the pulse of sources of long-term capital, and we see that these investors are more willing to have exposure to mining for the first time in our existence. They are diversifying away from oil and gas, which is a trend that will benefit mining but slowly.
The industry certainly needs to market itself better. Instead of being seen as dirty miners, we need to talk about the good that we can do for communities. Investors need to see mining as the best way to play the energy transition. There is lots of corporate rebranding going on but the message clearly isn’t getting across to investors.
What type of gold projects will fare best in the ESG investment environment?
MWS: We will see the mining world being segregated between the haves and the have nots. The haves, do ESG very well, which gives them more liquidity and allows them to access lower cost financing. These advantages will eventually turn into a valuation spread that will allow the haves to buy the have nots and improve their operations. We will see a bifurcated commodities market, with more inflows into energy transition commodities compared to those that don’t tell the energy transition story well enough. And that will create differential movement around those commodities.
People are asking why gold isn’t performing better in this inflationary environment. You can argue that investors are factoring in future fiscal policy and higher rates but, however you look at it, gold has underperformed. That wouldn’t prevent Appain from investing in gold as we are relatively commodity agnostic, as we rather focus on technical fundamentals of an asset rather than the beta case.
Investors love the energy transition, but we are here to make defensive, asymmetric investments where we won’t lose money and there is the potential for upside if the company finds resources or the beta / commodity price hits. So, we will invest in gold if it is low capital intensity with low-cost production and a high grade.
Can you please give investors an update on the Atlantic Nickel dispute with Sibanye-Stillwater?
MWS: Sibanye-Stillwater unlawfully terminated their binding SPAs, which is something we can not accept out of principle. They then put out a lot of public statements which are factually incorrect. One wonders what suddenly caused them to lose interest in the acquisition when their thematic has long been energy transition. In hindsight, they probably wish they had done the deal.
What investment opportunities does Appian see being created by the energy transition, inflation and geopolitical conflict?
MWS: These three themes are intertwined. Security of supply and nearshoring will make opportunities that are close to end users more viable, so if you are a long-term investor, you start looking close to where material needs to go and invest in projects in nearby jurisdictions. It also creates investment opportunities in non-energy transition stocks because beta investors are flooding into pure energy transition stocks. Mineral sands and some precious metals, for example tin for semi-conductors, are interesting commodities that are being overlooked because they can’t tell their energy transition story.
The Russia Ukraine conflict is tragic and at Appian we are doing our best to help. It will create interesting investment opportunities in the long-term however, and Potash is one that we mentioned. Russia also controls 32% of global diamond supply. Nickel, platinum and palladium will also be impacted.