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Commodity prices have slumped and costs have escalated, squeezing the margins of major mining companies. Falling equities of junior miners have scared investors away along with the capital to keep themselves afloat. Necessity is the mother of invention, however, and many mining companies are learning that the key to survival is doing things differently.
* Editing note: E&Y report excerpts italicized.
In the first report, euphemistically titled “Headwinds continue,” E&Y looks at how an index of mining companies called The Canadian Mining Eye performed over the last quarter. The report then goes on to discuss four ways that companies are aiming to attract alternative methods of financing and optimize capital, identify the quarter’s winners and losers and pinpoint those companies that raised the most funds in Q1.
The second report focuses on the business risks that mining companies are facing this year and into 2014, with the most important takeaway being that capital allocation and access to capital — the number-eight business risk in 2012 — has “rocketed to the top of the business risk list for mining and metals companies globally,” according to E&Y.
These capital dilemmas are strategic risks that threaten the long-term growth prospects of the larger miners at one end of the sector, and the short-term survival of cashstrapped juniors at the other end.
Both reports are good reading for resource investors seeking to better understand the risk-return equation and how the better companies are adapting to new realities.
Headwinds continue
Mining equities have faced the double whammy of low economic growth and falling commodity prices, and that has caused the Canadian Mining Eye index to close down 13 percent in the first quarter and 33 percent over the past year. That compares to a 3-percent gain by the S&P/TSX Composite Index (TSX:OSPTX) in the first quarter.
The Canadian Mining Eye tracks the performance of 100 TSX and TSXV companies with market caps ranging from $250 million to $2.5 billion.
Looking at share prices of different commodities over the past quarter, E&Y makes clear that some sectors have fared better — and worse — than others. Companies specializing in fertilizer minerals and technology minerals suffered a near 40-percent drop in Q1, while gold and silver companies were off between 15 and 20 percent. The base metals sector declined by less than 5 percent. On the upside, companies working in diamonds, uranium and platinum group metals were all up, with the diamond sector leading the increase at around 20 percent.
Of interest to investors is how companies are coping with the problems of restricted access to capital and escalating costs. E&Y names four strategies:
- Strategic mergers and acquisitions: A number of companies entered into mergers and acquisitions to sustain growth and expanded inorganically. Ex. Coeur d’Alene Mines (NYSE:CDE,TSX:CDE) announced the acquisition of Orko Silver to diversify its portfolio and gain control of Orko’s undeveloped silver deposits in Mexico.
- Non-traditional financing: A number of companies were looking out for more innovative forms of financing to avoid equity dilution. Ex. Northern Graphite (TSXV:NGC) entered into an equipment financing agreement with Caterpillar Financial Services to buy a mobile mining fleet and natural gas-powered generators.
- Non-core asset disposals: Some companies announced disposal of non-core assets in order to raise cash and focus strategically on their core business. Ex. Lake Shore Gold (TSX:LSG) sold its Mexican properties to Revolution Resources to focus on its Canadian assets.
- Capital recycling: Companies also looked at divestment as a means to raise capital. Ex. Ivanplats (TSX:IVP) sold a 15% stake in the Kamoa copper project to the Democractic Republic of the Congo.
The report identifies five winners and four losers last quarter from the Canadian Mining Eye index. The best-performing company was Imperial Metals (TSX:III), developing the Red Chris Mine in BC, whose share price rose 24 percent. The worst performer was Manitoba-focused San Gold (TSX:SGR), which slumped 63 percent. Other winners were Altius Minerals (TSX:ALS) (+23 percent), Centamin (TSX:CEE,LSE:CEY) (+22 percent), Katanga Mining (TSX:KAT) (+22 percent) and Uranium One (TSX:UUU) (+19 percent).
Apart from San Gold, the other dogs on the list include Rainy River Resources (TSX:RR) (-47 percent), General Moly (TSX:GMO) (-45 percent) and Mirabel Nickel (TSX:MNB,ASX:MBN) (-43 percent).
Poor market conditions also claimed three victims in the form of companies that delisted from the TSX: Northland Resources, Rio Verde Minerals and Talison Lithium. These were replaced by four new listings on the Toronto Venture: Galway Gold (TSXV:GLW), Coventry Resources, (TSXV:CYY) Delta Gold (TSXV:DLT) and Trident Gold (TSXV:TTG).
The health of a stock market can be measured partly in terms of the number of financings it has attracted. Based on this criteria, the TSX/ TSX Venture looks decidedly sick, with equity raisings last quarter skidding to about half of what they were in the fourth quarter of 2012: $1.157 billion versus $3.005 billion. Quarter to quarter, fundraising across both the TSX and the TSXV fell by a third. There were 489 financing deals in Q1 and no IPOs, compared to 489 deals in the first quarter of 2012, and 14 IPOs.
Still, there were a few stand outs, notably: Santacruz Silver (TSXV:SCZ) raised $40.4 million, Guyana Goldfields (TSXV:GUY) $100 million, NGex Resources (TSX:NGQ) $34 million and MBAC Fertilizer (TSX:MBC) $34.5 million. Platinum Group Metals (TSX:PTM) brought in $180 million and Karnalyte Resources (TSX:KRN) raised $44.7 million.
Business risks facing mining and metals 2013-2014
There is a disconnect right now between mining companies’ long-term strategies for growth, which tend to revolve around business cycles, and the goals of investors, who tend to have a short-term investment horizon and are uncomfortable with cycles.
There is a profound risk that the decisions taken by mining and metals companies today could damage their growth prospects, destroying shareholder value over the longer term.
Mining companies have been protected for years by higher commodity prices, but that has concealed, until recently, the impacts of rampant inflation, falling capital and poor capital discipline, notes E&Y:
A weak external environment and the lack of investor confidence have heralded an industry-wide directional change from growth for growth’s sake towards long-term optimization of operating costs and capital allocation.
This shift has not come about by choice. Mining companies are being forced to protect their margins and increase productivity, in this new era of lower prices and rising costs:
Softening commodity prices in an environment of high costs are continuing to squeeze margins. Companies have responded with sector-wide redundancies, mine closures and divestments of non-core assets.
There is also a renewed focus on improving productivity by removing inefficiencies across the organization that were allowed to creep in during the period of high commodity prices. Even a return to the productivity levels of labor and equipment that existed a decade ago would yield major benefits to margins.
Meanwhile, the junior mining sector has a different problem: access to capital.
The dramatic and continuing sell-off in equity markets has starved the junior end of the market of capital at levels we have not seen in 10 years. Companies with a market value of less than US$2 million — about 20% of listed mining companies across the main junior exchanges — had on average less than US$1 million in cash and equivalents on their balance sheets at 31 December 2012.
The report is thin on the problems related to capital access, making the rather trite observation that “[t]he cash and working capital position of the industry’s smallest companies is so severe that many are not in a cash position to wait for market conditions to improve.” However, the authors give a faint ray of hope “in the form of private capital investors who are favoring the juniors with more advanced projects.”
Ernst & Young’s top 10 business risks, ordered from highest to lowest importance, are:
- Capital allocation and access
- Margin protection and productivity improvement
- Resource nationalism
- Social license to operate
- Skills shortage
- Price and currency volatility
- Capital project execution
- Sharing the benefts
- Infrastructure costs
- Threats of substitutes
Number 10 is described by E&Y as a “newcomer” to the list of business risks, and says “its most acute ramifications are being felt across North America.” This family of risk refers to single-commodity companies or those in which one commodity is dominant. Examples include the US shale gas boom that has led to coal being substituted for lower-priced gas; aluminum for steel; palladium for platinum; aluminum, plastics, fiber optics or steel for copper; and pig iron for pure nickel.
Securities Disclosure: I, Andrew Topf, hold no direct investment interest in any company mentioned in this article.