BlackRock World Mining

Wednesday, January 9, 2019 - 15:48

Mining

BlackRock World Mining Trust celebrates its 25th anniversary this year.

Over the last 25 years, the team has demonstrated a strong track record and is now one of the most experienced teams of specialist investors in the metals and mining sector globally. Over this time, the team has developed strong relationships with company management teams, which helps them fully understand each company’s aims and strategy.

As we noted earlier in the year, the managers went into 2018 relatively bullish on the prospects for the sector. Whilst this confidence has not yet been rewarded, the managers’ central investment thesis remains that mining companies will be disciplined in terms of capital expenditure, and will continue to prioritise deleveraging and returning cash to shareholders for much longer than the market is giving them credit for. As such, BlackRock continues to believe shareholders will enjoy the benefit of strong dividends from underlying companies over the short term, but over the medium term, once the wider market catches on to the fact that capital discipline is here to stay, the managers expect a rerating.

Aside from electric vehicles, which remains a major theme within the trust through copper, lithium and cobalt exposure, the team is developing a “green metals” theme in the portfolio. Recognising increasingly strict environmental regulations, as well as the evolving preferences of consumers, the managers have been investing in companies which can produce aluminium either carbon free (Alcoa and Rio Tinto), or with a significantly reduced environmental impact (such as high grade iron-ore). The managers are also looking at how demand for metals will change over time, and as such have introduced a new holding in Umicore, which specialises in the recycling of metals and battery components.

On it’s 25th Anniversary, BRWM has achieved strong returns for investors since it’s launch, both relative to generalist global funds and the MSCI ACWI. Whilst there have been good and bad periods to time an investment since then, the trust has made strong returns over the benchmark (demonstrating the benefits of being an active manager), and this has shown that it pays to take a long-term view on the sector.

BRWM’s outperformance has usually been achieved during periods of positive sentiment. 2016 and 2017 gave grounds for optimism on performance, but over five years, the trust is marginally behind the benchmark, with much of the underperformance attributable to the write-off of the Marampa royalty in the summer of 2014. So far this year, performance has been more challenging. However, the managers observe that whilst global equities are near all-time highs in terms of historical valuation ranges, the mining sector has struggled to make ground, which may mean it has an element of relative protection should the current “growth correction” become more entrenched.

The trust’s historic dividend yield is 4.5%. The managers use the company’s low-cost gearing to ensure that investors have a full exposure to equities, but benefit from a diversified income stream stemming from other investments in bonds, convertibles, and the Avanco royalty contract. Aside from these revenue sources, the managers also make use of option writing to boost income from the portfolio.

The trust’s discount has remained resolutely wider than the 10% level. Indeed, the board has been buying back shares since the interim results, with the last buyback on a 16% discount. This is in marked contrast to Global investment trusts which have seen their discounts continue to narrow.

Portfolio

The trust’s objective is “to maximise total real returns to shareholders through a world-wide portfolio of mining and metal securities” and its benchmark is the EMIX Global Mining Index. Over the 25 years that the Trust has been in existence, the team has demonstrated a strong track- record and is now one of the most experienced teams of specialist investors in the metals and mining sector, globally. The team has developed strong relationships (with resulting good access) to company managements, which helps them fully understand each company’s aims and strategy. Whilst the approach has always been to deliver total-returns, there has been a shift over recent years (echoed by the sector as a whole) towards income being more a part of the total return than had historically been the case. This reflects the board’s view that a “significant” dividend will serve as an effective discount control mechanism.

As we noted earlier in the year, the managers were very bullish on prospects for 2018. They believed that the experience of 2015, in which global generalist investors panicked out of the sector on fears of widespread bankruptcies, has meant the subsequent recovery has been painful for many active managers who have remained on the sidelines. At the same time, it was a chastening experience for company managements, and the BlackRock team believes the memory of that will remain in their collective consciousness for years to come.

As such, the team’s central investment thesis is that companies will remain disciplined in terms of capital expenditure, and will continue to prioritise deleveraging and cash returns to shareholders for much longer than the market is giving them credit for. Indeed, this is one of the mainstays of the numerous inter-related themes that the managers are currently expressing through the portfolio. As such, BlackRock believes shareholders will enjoy the benefit of strong dividends from underlying companies over the short term, but over the medium term, once the wider market catches on to the fact that capital discipline is here to stay, the managers expect a rerating. Companies within this theme held by the Trust include BHP, Glencore, Rio Tinto and Vale.

Other prominent themes in the portfolio are companies which offer an opportunity to grow in an otherwise constrained environment. A good example in this category is copper producer First Quantum Minerals,which has projected unrivalled growth in copper production of 60% through to 2020/2021, with production from its Cobre Panama Project scheduled for Q1 2019.

Other prominent themes in the portfolio are companies which offer an opportunity to grow in an otherwise constrained environment. A good example in this category is copper producer First Quantum Minerals,which has projected unrivalled growth in copper production of 60% through to 2020/2021, with production from its Cobre Panama Project scheduled for Q1 2019.

Since last year, the managers have been increasing their exposure to small and mid caps within a “resource replenishment” theme. These companies are expected to grow production without depleting their reserves. Northern Star Resources and Fresnillo, are prominent examples here. Both are good examples of companies who have consistently invested in exploration and been successful in growing reserves and resources through the cycle.

When we met up with co-manager Olivia Markham, we understand that the team have developed an existing theme (previously “China supply side reform /increasing environmental standards”) to “green metals”. Recognising increasingly strict environmental regulations, as well as the evolving preferences of consumers, the managers have been investing in companies which can produce aluminium either carbon free (Alcoa and Rio Tinto), or with a significantly reduced environmental impact. An example of the latter is the high-grade iron-ore which Vale produces, which the Chinese government is prioritising over their own, domestically produced, low-grade ore, which has a significantly higher environmental impact when making steel. The managers are also looking at how demand for metals will change over time, and as such have introduced a new holding in Umicore which specialises in the recycling of metals and battery components.

Anticipating the opportunities presented by electric vehicles, the company has exposure to Lithium and cobalt stocks. The team did well out of being relatively early into these companies in 2017, but have experienced some volatility over 2018. We understand that the team believes that the long-term picture remains supportive given how long new resources take to bring into production. Alongside these stocks, copper is expected to be another beneficiary of electrification, with electric vehicles using up to four times as much copper as conventional vehicles, not to mention the extra infrastructure in distribution and recharging that will be required. The trust has 24% of NAV invested in copper bearing assets, of which c. 21% is in copper related equities. The most recently available breakdown illustrating this can be seen below.

Blackrock World Mining

Source: BlackRock

As we discuss in the gearing section, the managers have maintained gearing so that shareholders remain fully exposed to equities. The loan is largely invested in corporate and convertible debt, currently representing c.10% of portfolio assets. In this way, the managers are essentially arbitraging the rate at which BRWM can invest (currently 7-8%), relative to what it is able to borrow at (2.4%), thereby boosting the income distributable to shareholders.

The Avanco royalty contract currently represents 2.4% of the portfolio, which provides another source of income for shareholders. Since the initial US$12m investment was made and up to 31 March 2018, the Trust has received US$7.9m in royalty payments with the royalty on track to achieve a less than three-year payback on the initial investment. Avanco was acquired by OZ Minerals earlier in the year, which the team believes will be a positive development for their royalty investment. OZ Minerals have a significantly bigger balance sheet than Avanco had, and so Olivia believes that they will be looking to bring forward production and development plans at the mine over which royalties will be paid. As such, they remain optimistic on further upside under OZ Minerals’ ownership. At the current run rate, the Avanco royalty is contributing very healthily to the Trust’s income (7.5% of portfolio revenue over H1 2018, up from 7% in the last financial year).

Blackrock World Mining

Source: BlackRock

It is worth noting that the trust has a risk guideline that a maximum of 3% of NAV can be held in any unquoted investment and if that investment accounts for over 30% of the companies revenue, the listed equity position of the producer will also be included. There is an overall cap of 20% of the portfolio being invested in unquoted investments.

As we discuss below, NAV returns have been disappointing YTD, with the NAV declining by 8.3%YTD to end October.

In Olivia’s view, investors have been spooked primarily by the trade war between the US and China, but also declining confidence in the rate of economic growth in China, mistrust in mining management and uncertainty that current margins will be maintained. Countering these fears, Olivia notes that inventories around the world have declined, and commodities such as steel, coal and iron ore, which aren’t significantly influenced by speculators, have been trading well YTD. In her view, this gives grounds for confidence that worries are overblown, and we will continue to see healthy free cash flow, buybacks and dividends rising. Olivia also observes that in contrast to global equities, which remain near all-time highs, the mining sector is still rebuilding after the trough seen in early 2016. In the manager’s view, the fact that the mining cycle is completely out of sync with global equities offers a degree of reassurance.

It is worth noting that when compared to typical equity funds, BRWM is relatively concentrated (as is the benchmark), with the top 10 positions accounting for 60% of NAV. In total there are around 60 holdings. That having been said, BRWM is diversified when it comes to commodity exposure. The team aims to offer a significantly more flexible and dynamic exposure to commodities than that capable of being offered by the diversified miners, as well as diversify the risk to any commodity or company on the dividend – as we discuss in the dividend section, the trust weathered the impact of dividend cuts in 2016 significantly better than some of the diversified majors.

Overall, the equity portfolio remains exposed to higher- quality companies than the benchmark, which the managers believe remain disciplined as regards to capital allocation and are to some extent in a phase of “self-help” – that is, paying down debt and derisking their businesses, have good downside protection (the lowest cost producers) and have good exposure to the upside (long-term growth themes such as copper, lithium and cobalt etc).

Gearing

For quite some time, BlackRock World Mining has been in the low teens of gearing. The sector tends to be quite volatile (as witnessed in the performance section), and so this level of gearing might raise eyebrows. However, in the case of BRWM, the principal purpose of the gearing facility is to enable a wider diversification of income sources, whilst maintaining 100% equity exposure for investors. As we discuss in the portfolio section, the managers are effectively arbitraging what they are able to borrow at, and what they can invest at in fixed income or royalty investments. As such, the current gearing of 14% is effectively represented by the 12% in corporate bonds and the 2.6% in the royalty.

Gearing is provided by a flexible facility which the company can draw down or repay at any time, and is limited to 25% of NAV.

Blackrock World Mining

Source: Morningstar

Performance

Now celebrating it’s 25th Anniversary, it is worth standing back and reviewing what BRWM has achieved for investors since its launch. As the graph below shows, BRWM has been a very impressive investment for anyone who has owned it since inception. However, the graph also demonstrates what a rocky ride it has been over time. Certainly there have been good and bad times to invest, but the overall picture has suggested that strong returns can be made ahead of the benchmark (justifying employing an active manager), and that it pays to take a long-term view on the sector.

More recently, the trust has had a challenging time. BlackRock World Mining’s outperformance has usually been achieved during periods of more positive sentiment. For example, it significantly outperformed in 2009 and 2010. 2017 saw a return to outperformance, 3.2% ahead of the benchmark. However, the five- year period 2011 and 2015 represented five straight years of declines in NAV as well as the benchmark, whilst elsewhere equity markets globally saw gains. As a result, confidence in the mining sector reached a low ebb in 2016, but the performance of the managers in 2016 and 2017 gave grounds for a renewed sense of optimism, and hence the managers bullish stance going into 2018.

Blackrock World Mining

Source: Morningstar

Over five years, the trust is marginally behind the benchmark, with much of the underperformance attributable to the write-off of the Marampa royalty in the summer of 2014. The graph below also illustrates the fact that global equities are near all-time, whilst the mining sector has struggled to make ground over five years. The managers remain positive on underlying prospects based on fundamentals, but also because companies remain within the mid-cycle range in terms of valuation. As such, the divergence in fortunes between miners and other sectors has been quite stark, which the managers believe gives an element of protection should the current “growth correction” become more entrenched.

Dividend

The board believes that paying a “significant” dividend should serve as an effective discount control mechanism by stimulating demand for the shares from a wider audience. The board has committed to deliver a yield premium to the benchmark.

In order to deliver this yield, and make it sustainable, the managers have sought to diversify income sources and use the company’s low-cost gearing, so that the trust remains as fully invested in equities as possible, but benefits from a diversified income stream stemming from equities, bonds, convertibles, and the Avanco royalty contract. Aside from these revenue sources, the managers also make use of option writing to boost income from the portfolio. Overall income per share over the first six months of the year to 30th June was up 10.9% to 9.29p per share. As the graph below shows, this increase has been driven by a broad improvement across almost all of the sources of revenue. It is worth noting that sterling weakness is typically positive for revenues, given most companies price products and pay dividends in dollars.

Blackrock World Mining

Source: BlackRock

The total payout for 2017 was 15.6p, representing a yield on the price at the time of writing of 4.5%. As the graph below shows, this represented a marked step up (a 20% increase) over 2016, and was achieved with dividend cover of 1.06x. The board has undertaken to distribute “substantially” all of the company’s available income to shareholders going forward. The current year’s revenue performance so far provides more evidence that the 2016 dividend of 13p will, in time, be seen as the nadir of shareholder’s fortunes on the dividend front. So far the board has paid three quarterly dividends of 3p each. We understand that most of the major mining companies announce their dividends in February, so the picture for the final dividend will become clear soon after that.

Blackrock World Mining

Source: BlackRock

BRWM aims to be able to adapt and provide a more flexible allocation to commodities than the “diversified majors”. This should help provide a less volatile exposure over time, but in income terms, the team was also able to cushion the blow when the sector started cutting dividends aggressively in 2015/16. For example, whilst Anglo American and Glencore cut their dividends entirely, and BHP Billiton cut their dividend by 76%, BRWM cut the dividend by 38%.

The yield of 4.5% compares relatively well to other Global Equity Income trusts (average yield 3.7%) and the IA Global Equity Income sector, which currently has a median yield of 3.1%. At the last year end, the board has revenue reserves of just under a year (based on a dividend of 15.6p).

Management

Evy Hambro is lead manager on the trust, and has been part of the BlackRock Natural Resources team since the trust launched in 1993. Olivia Markham was appointed co-manager in 2015. She joined BlackRock in 2009 from her role as head of commodity research on the sell-side at UBS. Prior to this she worked at BHP in their M&A team. The co-managers are supported by a team of eight additional investment professionals within the Natural Resources team. In total, the wider team manages £13.2bn of assets.

Discount

As the graph below shows, the trust has suffered a widening discount so far this year. The Directors state that they “recognise the importance to shareholders that the market price of the Company’s shares in the stock market should not trade at a significant discount to the underlying NAV and the decision as to whether to buy back the Company’s shares is addressed regularly in Board discussions”.

Having not bought any shares back for quite some time, the company has started becoming active on buybacks. Over the period since the interim results were published in August, the company has bought shares back on four occasions. The most recent occasion was the 23rd October, when the trust bought shares on a c 16% discount.

As the graph below shows, the trust continues to suffer from a lack of buying, and the discount now looks increasingly anomalous – particularly when compared to the average discount for the Global investment trust peer group. The managers note that the mining sector is under-owned by generalist investors. Should this change, then the performance of the trust will likely improve measurably, and with an improvement in sentiment, the discount should narrow. In the meantime, the current dividend yield of 4.5% is attractive. It certainly compares very favourably with the IA Global Equity Income sector and AIC Global Equity income sector yields of 3.1% and 3.7%.

Blackrock World Mining

Source: Morningstar

Charges

The ongoing charge for the last financial year (2017) was 1% (1.1% in 2016) of NAV. The annual management fee is based on 0.8% of gross assets.

However, if the NAV decreases on a quarter-on-quarter basis, the fee will then be paid on net assets for the quarter. The trust does not levy a performance fee. The OCF is undoubtedly more expensive than the average OCF for global investment trusts (0.55% according to JPMorgan Cazenove), however BRWM is a specialist mandate and uses many non- standard tools to boost returns for shareholders – such as the use of option writing, investing in corporate bonds and convertibles, as well as royalty investments.

December 2018

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