Indonesia's Batu Hijau mine was a rich resource of copper for Newmont Mining, but conditions for continuing to operate in the country have become untenable, and with production expected to decline in the coming years, getting out now even if copper's price rallies, may be worth it. Image source: Newmont Mining.
Newmont Mining (NEM +2.48%) is getting out of dodge. Well, out of Indonesia, really, as it agreed to sell its 48.5% stake in its operations at Batu Hijau for $1.3 billion. Although the miner will still produce copper at its Boddington and Phoenix sites, Batu Hijau was responsible for the vast bulk of its annual production, meaning it's dramatically reducing its exposure to the metal.
Analysts are expecting copper prices to rally this year. According to a report published by Bank of America's Merrill Lynch unit, they're expecting prices to average out at about $2.25 per pound, well above the $1.95 per pound they had fallen to earlier this year. While the current rally has ignited fear that "production discipline" has been upset, a potential worry point because they believe the industry needs to have its supply contract by another 670,000 tonnes to get into balance, they still believe pricing will trend higher through 2020.
Unleveling the playing field
Yet Newmont Mining really had little choice for its operations in Indonesia. Following the government's decision to ban the export of raw, unprocessed ore or face usurious taxes for noncompliance, both Newmont and Freeport-McMoRan (FCX +0.77%) were left with few options. The law change was designed to boost local smelters, but the country had insufficient infrastructure to support the output. Newmont's Batu Hijau was the second largest copper and gold mine in the country behind Freeport's Grasberg open pit mine, which has the world's largest gold reserves.
Both miners have wrangled with the government over the edict since they had contracts of work in place that exempted them from such changes, and Newmont even had its license to operate suspended several times, though it was consequently restored after it committed $3 million to supporting Freeport's $3 billion smelter project.
Still, the pressure to exit Indonesia has been mounting. Earlier this year, Newmont reportedly received offers between $2 billion and $3 billion from a consortium of investors for its Indonesian assets, but the actual amount they're paying turns out to be just about half that amount and is below the $2.5 billion the miner says they're worth. But the timing may be right.
The amount Newmont receives will be comprised of $920 million in cash to be paid at closing with contingent payments worth up to $403 million that could be paid based on the price of copper.
The valuation might be less than what Newmont wanted, but it's also likely happy to exit the country. It's been unable to operate efficiently in Indonesia, and the unit has served as a drag. Plus, it has a goal to cut, over three years, as much as $1.5 billion from its $5.4 billion debt load. Most of the proceeds from the sale will go toward that target, but it could also mean the miner will use the opportunity to increase its annual dividend of $0.10 per share that currently yields just 0.25%.
Get while the getting's good
The sale of Batu Hijau then becomes a double-edged sword, allowing Newmont to cut debt, but possibly causing it to miss out on copper's coming rally. Even so, higher prices are not assured. BHP Billiton (BHP +1.46%) said its Olympic Dam project in Australia is positioned to increase copper output by 40% over the next year, with total production expected to hit 230,000 tonnes in five years, though it could go as high as 450,000 tonnes annually. It's a potentially lucrative resource for BHP as Olympic is the continent's largest open pit mine, and it is only just beginning to tap into the Southern Mine Area, which the miner says represents 70% of the ore body it has yet to touch.
Moreover, there are concerns that China's economy may not recover, and there is still exceptional uncertainty over how Brexit will impact the markets. Still, belief in a strong U.S. economy and an appetite for risk helped fuel a surge in copper pricing to its highest level since April.
Newmont has also said it expects attributable copper production at Batu Hijau to fall by half or more over the next two years as it depletes the higher-grade ores at the mine. It forecasts production to be between 120,000 and 160,000 tonnes in this year and next before tumbling to between 70,000 and 110,000 tonnes by 2018.
Because Newmont Mining was under some other presures to sell, its decision to sell its Indonesian assets is being made at a less than optimal time -- and for a below market value price -- but because the same risks that underpin copper's current rise also bolster the bullish case for gold, the company may still be able to fashion a new growth period ahead.
