Why Mining Companies Might Be Musk’s Next Target

Commodities Investing, Mining, Technology Stocks

Elon Musk has certainly been busy: first, he bought Twitter, and now there’s news that his car company, Tesla (TSLA), may be looking to take a major stake in one of the world’s mining giants.

The Financial Times reports that last year, Tesla began preliminary talks with Swiss commodities company Glencore (GLNCY) about taking a stake of 10% to 20% in the commodities company. The talks continued into March of this year; however, the discussions without a deal. The main hurdle seemed to be whether Glencore’s extensive (and highly profitable) coal mining business was compatible with Tesla’s environmental goals.

Here’s why I think Musk may go through with this deal…

Why Tesla Wants a Piece of Glencore

The reason behind the discussions is pretty obvious. Tesla, like all other automakers, is trying to secure future supplies of the raw materials it needs to produce electric vehicles and batteries.

Glencore produces cobalt, nickel, zinc, copper and other much-needed minerals, and is also one of the world’s largest battery recyclers.

Tesla already has a relationship with Glencore. Glencore is the world’s biggest producer of cobalt through its mines in the Democratic Republic of Congo, Australia and Canada, and two years ago, the company secured a cobalt offtake agreement with Glencore to supply its factories in Shanghai and Berlin.

In addition to its cobalt offtake agreement with Glencore, Tesla has struck a long-term deal for nickel supply from Brazilian mining group Vale SA (VALE).

Musk had previously outlined Tesla’s intention to take greater control of all manufacturing steps of its batteries, including processing the raw materials and even buying lithium deposits still in the ground, if the supply chain fails to deliver. Earlier this year, he tweeted: “Tesla might actually have to get into the mining & refining directly at scale, unless costs improve.” The price of lithium has risen eightfold since the start of 2021, and Tesla already is advancing plans to build its own lithium hydroxide refinery on the Texas Gulf Coast.

S-H-O-R-T-A-G-E-S

I do believe that Musk will eventually make a major investment into a mining giant like Glencore.

Supplies of those much-needed metals and minerals are limited.

Take copper, for instance. In 2021, Glencore was the world’s third-largest producer of the metal behind only Chile’s Codelco and Freeport-McMoran (FCX)—and as Freeport-McMoran’s CEO, Richard Adkerson, recently warned: “there is going to be a very significant shortage in copper.”

The impending shortage is due to global plans to cut carbon emissions and the resulting surging demand for copper for the rapid rollout of electric cars, renewable electricity generation, and power lines.

Copper is crucial for “greening” the global economy because of its ability to conduct electricity. An electric car uses three times the amount of copper as its combustion engine counterpart, while renewable energy projects tend to need five times the volume of the metal as traditional gas, coal, and nuclear power plants.

In a recent report, the commodities consultancy Wood Mackenzie said that over the next decade, 9.7 million metric tons of annual supply needs to come from projects that are yet to be approved. The current market size is about 25 million tons per year. As Wood Mackenzie noted in the report: “$23 billion of annual investment in new projects [is] needed, two-thirds more than the average over the past 30 years.”

Add to that, the fact that metals-producing countries now want a bigger piece of the pie.

A few days ago, Indonesia said it was looking to create an OPEC-style nickel cartel—and the country could do it. About 38% of world nickel supply comes from Indonesia, with another 23% from the Philippines and Russia.

Indonesia already has taken similar action. In January, it halted thermal coal exports from the country. As the world’s largest exporter of thermal coal, that move rocked the coal market, sending coal prices skyward. Companies like Glencore profited handsomely from the turmoil in coal.

I expect supply shocks in battery materials too. That will translate to more profits for the mining giants, including Glencore—whether Elon Musk buys a piece of it or not.

Glencore Dividend

Glencore’s profits more than doubled in the first half of 2022, breaking the company’s record and making it one of the biggest winners from the turmoil in commodity markets unleashed by the war in Ukraine. A strong performance from its aforementioned coal business accounted for almost half of the company’s record $18.9 billion in adjusted earnings. Its profits for the first six months of 2022 were up 119% from a year earlier, beating its previous half-year record.

Glencore’s marketing business, which uniquely sets the company apart from its pure mining peers by getting the company involved in commodities trading and not just production, also outperformed. It generated earnings of $3.7 billion, exceeding the $2.2 billion to $3.2 billion it had previously expected to make in 2022.

Thanks to these great results, Glencore laid out plans to boost returns for investors. It announced a $1.45 billion special dividend and a new $3 billion share buyback program that took total shareholder returns for the year to $8.5 billion.

For the year overall, Glencore forecasts adjusted earnings of more than $32 billion. It is on track to make annual pre-tax profits of $26 billion according to S&P estimates—about twice what it did in 2021.

I like to invest in these types of companies. Even amid rising inflation, firms like Glencore have high operational gearing. After revenues have covered fixed costs, a high proportion of additional sales turn into profits.

For example, the market price for coal has risen more than 200% amid the turmoil in Ukraine…yet, the Glencore coal division’s EBITDA soared 900%, to $8.9 billion!

And while commodity prices have cooled, they remain at elevated levels. Let’s not forget the news coming out of China that COVID restrictions will disappear next March. That will significantly boost demand for all sorts of commodities, sending prices higher once again.

Glencore shareholders will be generously rewarded when this happens. The forecasted payouts for 2022 total $8.5 billion, or about 12% of its market capitalization. I expect a similar payout in 2023.

The stock’s current yield is 6.29%. Add to that the Glencore ADR gained nearly 18% year-to-date, and you have a very nice total return. GLNCY is a buy anywhere in the $10 to $12.50 range.

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