Automotive industry’s shift towards lower emissions will up demand for catalytic converters
The SA platinum group metal (PGM) industry has been in a near decade-long downturn as demand shocks and a pessimistic outlook pushed prices to what we believe to be unsustainably low levels.
Unprofitable supply has been slow to reduce due to high barriers to exit. Sentiment towards the sector is incredibly low due to the labour-intensive, deep-level nature of SA’s industry as well as concerns surrounding the long-term demand for PGMs as the European diesel share declines and the world shifts towards electric vehicles.
The negative sentiment is so great that despite a 36% increase in the industry’s rand revenue basket to near record highs, most equity prices continue to trade at distressed levels. Only Amplats has had a positive return over this period.
PGM comprises five precious metals, of which platinum, palladium and rhodium are the most important. These are referred to as 3E metals. The demand side of the 3E market is dominated by catalytic converters for internal combustion engine (ICE) vehicles, making up 70% of global demand. We are optimistic about the market for the following reasons:
The outlook for global vehicle sales is good, driven by emerging markets.
We expect 3E demand to grow over the next decade as environmental legislation in China and the rest of the world forces car makers to use more metal in their vehicles.
We feel these new legislations are being underestimated. In the next five years, China, the largest vehicle market, will have the strictest emissions standards in the world.
The balance of the market is split between jewellery and industrial catalysts with 9% and 21% respectively. We expect this portion of demand to see slight growth over the next decade. The negativity on the demand side has been driven by the outlook for European diesel sales as well as the rise of battery electric vehicles (BEVs). While the outlook for European diesel is negative, it is important to note that it is only 12% of 3E demand and we do expect this to decline.
We believe in the long-term prospects of BEVs but are cognisant of the challenges facing the technology. Our key takeaway from the work we have done on the future of the vehicle industry is that the transition of the industry will be evolutionary rather than revolutionary.
Importantly, we see a period of mass hybridisation over the next decade before BEVs start to become more affordable for the mass market. We anticipate a shift towards a portfolio of technologies including BEVs, a variety of hybrids as well as fuel cell vehicles. As investors in the PGM sector, our biggest worry is BEV adoption, as these have no PGMs in the vehicle at all. In our forecasts out to 2030, we expect BEVs to make up 19% of global light-duty vehicle sales, up from 1% today. We expect the traditional ICE as we know it to decline from 96% today to 28%.
Currently, petrol vehicles predominantly use palladium in the converter, instead of platinum. Palladium is in material deficit and now trades at a $180/oz premium to platinum, where it historically traded at large discounts. We have gathered that platinum is a superior metal for catalysis and that a growing price differential will swing the original equipment manufacturers back towards platinum in future.
Many look at the platinum surplus and declare the metal is doomed. Our view is, given their fungibility, platinum and palladium must be considered together. Looked at this way, the market is in a growing deficit. Out of the 3E metals, platinum is most important for SA producers as it is makes up 60% of the ounces extracted.
We see 3E demand increasing 11% by 2030, where market rhetoric seems set on declining demand. Beyond 2030, we see large reductions in SA supply as many mines come to the end of their economic lives.
Coupling our supply and demand expectations gives us an average market deficit of 500,000oz, or 2.6% of annual demand each year, over the next 12 years. These deficits are substantially more pronounced in the near term and we expect prices to react strongly over this timeframe. We have excluded potential investment demand from these balances, which may prove conservative.
Negativity towards the industry also stems from the deep-level, high-cost nature of the majority of the SA mines. We have mitigated this through the selection of the highest-quality players in the sector, Northam and Amplats.
Northam is a medium-size producer with two producing mines, run by an entrepreneurial management team that has taken advantage of the downturn in the industry by making smart acquisitions.
Production growth from its Booysendal mine over the next five years will help the group double production. Booysendal is the key asset in Northam’s portfolio, and while it is underground, it is shallow, capital-light and mechanised — meaning a smaller labour component. Northam is well-positioned to generate cash flows and at these metal prices should trade on a nine times price-earnings (9xPE) ratio in the 2019 year.
Amplats is the largest producer of PGMs and has undergone a remarkable portfolio transition in the last five years. Shedding itself of high-cost, deep underground mines and focusing on the key Mogalakwena asset has allowed Amplats to pay the first dividend in the sector since 2013.
Mogalakwena is a unique asset as it is an open pit, which means it comes with less operational complexity and standout margins. It has material expansion capability over the next decade and we believe management will pursue this. Amplats has several options to expand the size of the portfolio over the next decade with high-quality, low-labour ounces. At today’s spot prices, Amplats trades on an 11xPE for the 2019 year.
The sentiment surrounding PGMs has left the sector’s equity prices lagging recent improvements in the basket price. Thanks to their high-quality operations, both Northam and Amplats can generate material cash flows in today’s price environment and we believe equities are yet to reflect this.
This article provided by NewsEdge.