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Want to know what’s wrong with the mining industry? PwC explains it all here. The takeway: it’s bad, but not all bad, and there is hope if the industry is willing to make some changes.
PwC’s 10th annual mining trends report, released last week, does not make inspiring reading for those hoping for a breath of fresh air in the mining industry’s generally recognized funk. But there are glimmers of hope that should not be glossed over amid the largely negative tone of the report.
Simply titled “Mine,” the report analyzes the top 40 mining companies by market capitalization in 2012, using the results to extrapolate general trends for the industry.
Below is a sort of “good, bad and the ugly” of how the mining industry looks globally, according to PwC. We then summarize PwC’s take on what is happening with China, how the top 40 are trying to regain the confidence of investors and a few other interesting tidbits/facts and trends.
The overall message from the report is that mining right now is facing a crisis of confidence. While that is not a surprise to anyone who follows the sector, the numbers paint a compelling narrative of what has happened, why and the way forward.
* Editing note: PwC report excerpts italicized.
The good
While mining stocks have suffered since the beginning of 2012, the long-term trend looking back 10 years is positive.
From January 2003 through April 2013, mining stocks are up 235%, while the Dow Jones is up 82% and the FTSE 100 is up 78%. While mining stocks have not fully kept up with commodity price increases, they have beaten the broader markets. Although mining stocks have been more volatile than broader markets, falling harder during the global financial crisis and other dips, performance for the last decade is still good.
2012 was a good year for diversified miners.
From a market capitalisation perspective, the top 5 increases in 2012 had a combined gain of $61 billon. This included BHP Billiton, Rio Tinto, Xstrata, Grupo Mexico and Inner Mongolia Baotou Steel Rare Earth Hi Tech—three diversified, one copper, and one rare earths producer.
The United States is expected to perform better this year and next.
As credit and housing markets begin to revive, the US is expected to outperform most other G7 countries, with projected real GDP growth of 2% in 2013, increasing to 3% by 2014.
There is a renewed focus on rewarding shareholders through higher dividend payments.
In 2012 the Top 40 paid out record dividends—increasing the dividend payout ratio from 25% in 2011 to 57% in 2012. From 2009 to 2012, the Top 40’s dividends have increased by more than 150%, from $15 billion to $38 billion.
Despite taking huge writedowns last year, mining companies are still acquiring assets.
Notwithstanding the record impairments recognised during 2012, the total asset base of the Top 40 has continued to increase at an average of 21% per year over the past ten years and set new records this year with total assets exceeding $1.2 trillion.
The bad
The uptick in mining and energy stocks that characterized the last quarter of 2011 came to an abrupt end at the dawn of 2012. Values have since fallen precipitously, with the chief beneficiaries being non-mining equities that are considered safer investments.
Since January 2012, the HSBC Global Mining Index fell by 30% while the broader markets rallied—the Dow Jones hit an all time high. Since January 2012, the HSBC Global Mining Index has underperformed the Dow Jones and FTSE 100 by 46% and 43%, respectively.
Which sector was worst hit in 2012? By far the gold miners.
Of the five companies whose market capitalisation shrunk the most, four were gold producers—Barrick Gold, Anglo Gold Ashanti, Goldcorp, and Newmont. In 2012 the Top 40’s gold miners lost $29 billion or 15% of market capitalisation.
The ugly
Return on capital invested (ROCE) has dropped to 8 percent, even lower than than the negative 9 percent ROCE during the financial crisis. Why?
When commodity prices picked up three years ago, the industry rushed to bring capacity online, setting new records for capital expenditures, but in the process, decreasing productivity. The industry’s operating costs have also increased faster than other industries, impacting margins. Head grades have fallen, mines have deepened, and new deposits are in riskier countries. With the structural change in the cost base that has occurred, moderate price increases will not be enough to claw back lost margin.
Net profits are down 49 percent, to $68 billion, a level seen in 2006, and net profit margins are at 13 percent, the lowest since 2003. A big part of that has to do with increasing costs, which rose 9 percent, to $340 billion. For some companies, it made more sense to write projects off in 2012 than to try and justify them to shareholders. Simply put, some of these acquisitions were just poor decisions.
At $45 billion, impairments for the Top 40 were up nearly 50% more than the previous highest year over the last 10 years. 80% of the impairments recognised over the past year were by companies representing the traditional markets, many of whom completed acquisitions at the height of the market.
The ugliness didn’t stop with the end of the 2012 calendar year. The year so far has been truly horrendous for the top 40, states PwC, offering the following metrics for proof:
Market capitalisation fell for 37 of the Top 40—losing over $200 billion, or 17% of the year end 2012 level. Only Minera Frisco, Mosaic and Inner Mongolia Yitai Coal had increases in market capitalisation. The Top 40’s gold miners lost a further $58 billion, particularly due to a significant sell-off in April following the largest one day drop of gold prices ever.
At $11 billion, free cash flow reached the lowest level since our inaugural Mine in 2003. The year-on-year decrease of 85% was larger than the biggest previous decrease of 50% experienced during 2009.
The way forward
Still, it’s not all bad. The major mining companies have realized that they need to make some big changes to their business models and how they reward shareholders for loyalty. Here are some of the ways they are trying to regain the confidence of mining investors:
- Pay out more dividends. Based on April 2013 share prices and 2012 dividends, the Top 40’s dividend yield is now almost 4%. In 2012 the Top 40 paid out record dividends—increasing the dividend payout ratio from 25% in 2011 to 57% in 2012. From 2009 to 2012, the Top 40’s dividends have increased by more than 150%, from $15 billion to $38 billion.
- Reduce capital spending. Although 2012 was a record year for capital spending, the overall message from the Top 40 is that the capital expenditure tap is being tightened. Project hurdle rates have been increased, with some of the Top 40 stating that only projects with a return above 25% will be pursued.
- Take advantage of cheap debt financing. With cheap debt financing available, the Top 40 took advantage and leveraged up their balance sheets, adding $108 billion in debt in 2012. Cheap debt has helped to maintain liquidity flexibility. Bond proceeds of $43 billion were over double 2011 as the Top 40 turned to debt to access capital for expansion and refinancing. In contrast, junior miners are struggling to raise finance. Even those prepared to pay high interest rates cannot get it. Debt is hard to come by. Combined with an apparent drought in the equity markets, you have a perfect storm for the demise of many entities which play a critical role in exploration. If junior funding does not improve soon, this will have a dramatic impact on the pipeline of new reserves.
- Change CEOs.The scale of change in CEOs in the last 12 months is unprecedented, with 50% of the Top 10 CEOs changing since April 2012. The new CEOs reflect the industry’s focus away from M&A, (a trend noted in our Global Mining Deals: Down, but not out) and towards achieving operational cost improvements and delivering projects on budget.
- Divest non-core assets. With the increased pressure from shareholders for investment returns and the shift in focus from growth to delivering profits, it has become a focus of the larger players to focus on getting the most out of their “tier 1” assets while divesting of their non-core assets.
What’s happening in China?
No global mining report would be complete without some discussion of the situation in China, the world’s largest consumer of metals. PwC makes the same argument many mining analysts have made recently: even though growth is slowing in China, the growth is measured against a much larger economy than 10 years ago, meaning demand for metals in the Middle Kingdom will remain high.
In the next eight years China’s economy won’t grow as fast as the last eight years. But, it will still grow, continuing to drive increased demand and being the centre of the industry’s consumption story. Domestic supply, particularly of coal, will continue to grow.
What is perhaps more interesting is PwC’s assertion that more mining companies from China will become part of the top 40 in the near future.
Chinese companies will likely consolidate and with a few domestic mega-mergers and large overseas acquisitions, Chinese companies will likely be a large part of the future Top 40, if not the Top 10.
We can already see that in the fact that Inner Mongolia Baotou Steel Rare-Earth (SSE:600111), China’s largest rare earths producer, is among the top 40 in 2013, along with six other Chinese mining companies.
Which sectors dominate?
Despite the media attention hogged by gold mining companies, it might surprise some that the lion’s share of mining revenue comes from less lustrous sectors. Of the top 40’s total revenue, over half — 64 percent — comes from copper, coal and iron ore. Of those, iron ore has eclipsed copper as the main revenue getter among the diversified miners, notes PwC:
Iron ore made up 38% of the Top 5 Diversifieds’ total revenue in 2012. This is nearly double 2007, when iron ore contributed 20% of total revenues and copper dominated at 25% of the total.
Are mining companies up to the challenge?
It’s hard to reach a positive conclusion from the raft of negative numbers proffered in PwC’s report, but the consultancy does its best. The mining industry is clearly at a crossroads and shareholders are demanding change. Will they get it? That depends on the industry, which has never been quick to adapt.
“Now is the time to show that the industry can deliver in good times and bad,” stated Tim Goldsmith, global mining leader and mine project leader at PwC, who along with most in the mining industry right now, is taking the longer-term view:
“While currently there may be a confidence crisis, we have faith that the long term fundamentals will ensure mining is a great industry to be in for many years to come.”
Read the full PwC report here.
Securities Disclosure: I, Andrew Topf, hold no direct investment interest in any company mentioned in this article.