Gold, copper and a robust pipeline of deals provided the highlights in a tough 2015 for Australia’s mid-tier miners
The last financial year left little to celebrate for Australia’s 50 largest ASX-listed miners with market capitalisations of less than $5 billion. Falling commodity prices coupled with poor investor confidence saw the combined underlying market cap of the mid-tier 50 decline by 16 per cent, with revenues, gross margins and cash flows all falling away.
But there were a couple of bright spots that offered hope for those prepared to take a long-term view. Miners who held gold and copper assets were helped along by the falling Australian dollar, and the deal pipeline looks strong after a quieter year.
So what can the last financial year tell us about what’s ahead and, more importantly, what can Australia’s mid-tier miners be looking to do right now to help them prosper in the future?
The financial year that was
Bulk commodities took the brunt of the beating in FY15. The combined market cap of the bulk commodity players in the mid-tier 50 is now less than the value of their net iron ore and coal assets by $1.5 billion and $4.1 billion respectively. Across the entire mid-tier 50, the difference between net assets and market capitalisation is just $1.1 billion.
Impairment losses totalled $5.5 billion in FY15, mirroring the $5.5 billion in write-downs the year prior. Revenues declined 1.8 per cent to $28.1 billion during the year, with gross margins declining to 22 per cent, compared to 25 per cent in FY14. The continued margin squeeze can be attributed to worthy productivity improvements and cost control initiatives failing to keep pace with plummeting commodity prices.
Elsewhere, preservation of cash, repayment of debt and the diversion of operating cash flows to fund capital expenditure highlighted the difficult environment for attracting capital investment.
Light at the end of the tunnel
On the upside, companies holding gold and copper assets proved to be the shining lights of FY15.
Gold companies benefitted not only from an increased Australian dollar gold price, but also increased production. With oil prices and mining services costs also dropping, it was actually a more favourable cost environment post-boom. As a result, the gold sector increased its share of the total revenues of the mid-tier 50 from 39 to 44 per cent, and also accounted for 63 per cent of the gross margin across the group.
Copper, while representing only five per cent of the collective revenues, accounted for 12 per cent of the total gross margins. In FY15 the gross margin on copper itself increased to 54 per cent, making it the most profitable commodity across the mid-tiers. Looking ahead, the long-term economic fundamentals that underpin the demand for ‘lifestyle metals’ such as copper remain sound. Despite the slowdown in construction in China, urbanisation and the resultant shift of the population into the middle class continues apace, which bodes well for the future demand of lifestyle metals.
Time to do a deal?
Compared to previous years, the transaction climate around mid-tier Australian miners was subdued in FY15, confirming the general uncertainty regarding short- to medium-term performance of the industry. The total value of the five deals in the 12 months to 31 August 2015 represented only 64 per cent of the value of completed transactions for the prior year.
But is this all about to change? Our analysis indicates there is a strong pipeline of pending deals, spurred by a market appetite for low-cost gold and nickel projects and ongoing divestment programs by large mines. With the sector well out of favour, many old-school miners are keen to show their expertise at picking quality assets in the end-of-boom sales!
As at 31 August 2015, the total value of pending transactions is estimated to be $3.1 billion, up from $396 million at the same time last year. Of the total deals done in the year to 31 August 2015, including those pending but yet to be completed, gold was a clear standout based on the deal value and number of transactions. Gold deals represented 64 per cent of total deal value and had an average deal value of $326 million.
The remainder of the commodities were relatively quiet from a transaction perspective, with only a single deal in both iron ore and coal completed during the year.
Will private equity fill the capital gap?
In the last 12 months the market capitalisation of the mid-tier 50 has reduced significantly, corresponding with poor investor confidence and subdued Chinese growth.
With external factors hammering mining valuations, the mainstream capital markets appear to be growing impatient and disillusioned. Risk-averse investors have shown little interest in companies with slowing and uncertain earnings and, on a broad level, are increasingly eager to reduce exposure to the industry’s cyclical nature.
Notwithstanding the dynamics of demand and supply, the destruction of value partially reflects a disproportionate shareholder focus on short-term earnings; however, pressuring miners to minimise operating and capital expenditure for the sake of more palatable year-on-year accounting metrics and press releases is not a sustainable long-term strategy.
Insufficient consideration is being given to assets with long-term growth potential and cash flow pipelines. On the back of these deteriorating valuations and low stakeholder appetite, the market’s short-termism has reduced the availability of traditional capital sources.
Although mainstream private equity has historically avoided the resources industry, there has always been a number of mining-specific private equity providers such as Resource Capital Funds (RCF), Sentient and AMCI; however, the sudden decline in commodity prices has given birth to a number of new mining-focused mandates.
Unlike mainstream private equity, which has a greater aversion to cash flow volatility and long-term horizons, the cashed-up new players in the mining sector are motivated by attractive valuations and a resilient demand story. Backed by sophisticated investors – some with industry connections – these firms are waiting patiently and quietly, incentivised by a desire to uncover undervalued assets in Australia’s largest export industry.
These funds understand the sector and its risks and, in comparison to current sentiment, are willing to take a long-term view. To borrow a Wall Street proverb, they are looking to buy straw hats in the winter.
Unlike mainstream capital sources, these private funds will consider a range of flexible investment structures to match a project’s unique risks and opportunities. We also expect some of these funds to be commodity agnostic, targeting undercapitalised or capital-starved growth assets. Projects likely to be in their sights include advanced developments, scalable operating mines or distressed projects with high cash flow potential.
For Australian mid-tier miners, the increased participation of mining-specific private equity could provide management with the capital they need to develop quality projects. Contrary to the mainstream equity market short-termism, sophisticated private equity war chests appear to be increasingly motivated to finance high-quality mining assets.
Will 2016 be the year alternative capital deploys on a wider scale? The valuations are primed and the industry is ready; for private capital it’s now or never.
Digital technologies to drive safety and productivity
Digital technologies provide a tremendous opportunity for miners to realise the productivity and cost management dividends they’ve been searching for. But the challenge for miners is the extent to which they can successfully implement this technology and leverage the data to its full potential.
Digital technologies are driving connectivity and mobility faster than ever. Increasingly, equipment, systems, people and devices are being linked to the internet and to each other. When combined with predictive analytics – that is, using data to predict when things might occur – this connectivity can help inform decision-making on precursors to safety incidents, deviations from safe operating limits and insights on the mental and physical health of a workforce.
Mobile applications have the potential to remove manual and time-consuming processes for safety observations, inspections and audits, hazard analysis and reporting of hazards and incident events. Importantly, they can also provide insights into issues in real-time, allowing for speedier resolution.
With respect to mine safety, there are a number of digital and analytic trends that will improve mine site safety in the future. For example, sensors are relatively low-cost devices that capture a wide variety of information being used to provide visibility into operations and improve context-specific decision-making.
Beacons allow for device interaction based on proximity, such as communicating with a nearby smartphone application. Beacons can also house sensors to capture and transmit data, which help track and manage safety-related interactions between workers and machinery.
This technology makes it possible to develop items such as ‘smart clothing’ where sensors are woven into the fabric of clothing and used to capture and transmit data such as a wearer’s location. Wearable device technology can currently measure heart rate, respiratory, oxygen and emotional states.
Biometric identity wristbands such as the Nymi device use your heart’s unique signature to confirm your identity. This could provide organisations with a seamless way to ensure security around restricted areas, such as providing access to equipment and vehicles.
On the operations side, code-free software now allows the creation of integrated operations models that can be used to calculate the impact on the business of forecast scenarios. This enables mining managers to optimise mining operations while taking into account operational constraints such as equipment capacity and efficiency, processing, headcount capacity, funding and regulatory requirements.
The integration of operational constraints with financials creates optimisation models that are much more powerful than traditional business intelligence reporting tools.
Prescriptive analytical tools ensure internal data consistency and can identify where outcomes are not physically achievable in real-world operations.
Analytics that fully integrate the entire value chain in the organisation (from exploration to market and from operations to financials) allows a management team to make decisions that are not only timely, but which are based on a comprehensive understanding of the inputs to – and likely outcomes of – those decisions.