The world’s top 40 mining companies were in a race to the bottom in 2015, with falling market capitalisation and net losses leaving them slower, lower and weaker according to PwC’s Mine 2016 report
Mine 2016 is PwC’s 13th annual review of global trends in the mining industry. Its analysis is based on the financial performance and position of the global mining industry as represented by the top 40 mining companies by market capitalisation.
In 2015, the world’s top 40 mining companies experienced their first ever collective net loss, their lowest return on capital employed, unprecedented capex containment and the tag team effect of prevailing debt levels plus impairments, which sent leverage to new heights. The miners are currently operating in an environment where there is less free cash, a lower appetite for expansion from lenders and shareholders alike and infringements arising from past decisions. While the beginning of 2016 saw sporadic rallies, many of these aspirations were quickly snuffed.
This is unchartered territory for the industry at a time of rapid change in all sectors of the global economy. However, it is not all doom and gloom. It is within the power of the leading mining companies to rebuild their investment propositions. Significant restructuring needs to continue, and deal volumes are likely to reshape the industry ownership mix and hierarchy in the near future. Costs have already been cut deeply, but need to be demonstrably sustainable at these levels if prices stay depressed. Pressure will rise as attention turns to the next wave of productivity initiatives, which will have long-term paybacks and require fundamental rethinking of structures, processes, systems, technology, organisational designs and capability needs. In addition, all players need to recognise that the energy landscape is changing and new world disrupters will have a role to play.
Over the past decade, global commodities demand and prices were largely driven by unprecedented Chinese growth. In the medium term, China will continue to be crucial to the prosperity of the mining industry. Representing approximately 40 per cent of global demand, China cannot be ignored.
However, China can no longer be relied on as the sole driver of prosperity in the sector. China’s new economic plan highlights the nation’s aspiration to transition from a manufacturing-based economy to a service-based one. As this transition gains momentum, China’s rampant demand for raw commodities seen during the boom will not be replicated.
Chinese GDP growth is forecast to tail off and hover around six per cent annually to 2020, which is a significant decline compared to recent decades. Nevertheless, China continues to grow and will remain a critical part of the mining industry’s story.
Looking for a new ‘saviour’ to replace China is not an option. While there are a few notable growth regions, including the ASEAN nations and the Indian subcontinent, which will assist with future growth, even the most bullish observers agree that there is no new China on the horizon.
For more than a decade, the combined market capitalisation of the top 40 mining companies has closely tracked spot commodity prices (Figure 1).
The market capitalisation for the top 40 was $494 billion at the end of 2015, which represented a 37 per cent decrease from 2014 and the lowest level seen since 2004. All gains made during the commodity super-cycle were effectively wiped out. The collapse was all the more painful for producers in 2015 because the value destruction was perceived as being self-inflicted, whereas during the global financial crisis, extraneous market forces drove valuations down across multiple sectors.
The current market capitalisation of the top 40 is only a third of its value from five years ago, retracing its steps to the position that it held prior to the huge spending that occurred to expand supply at a time when demand was slowing.
Only nine of the top 40 companies showed increases in market capitalisation. Of these, four were gold companies, reflecting the stronger performance of gold relative to the other commodities.
The strong correlation between the perception of the future earnings potential of the industry and short-term commodity prices is concerning given that mining is clearly a long-term game. Although management of the top 40 has a long-term investment focus, many shareholders struggle to overcome a ‘spot mentality’ and are much more focused on the short term. This impacts on the capital available for allocation in a declining market, eventually constraining supply and the conditions necessary for a new cycle to begin. When it does, shareholders will hope that capital discipline is better than during the most recent boom and that returns on equity will be commensurate with the risks being taken. Until then, the industry will remain slower, lower and weaker.
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Capital expenditure versus impairment
Impairments of $53 billion in 2015 may not be an absolute record, but at 77 per cent of 2015’s capital expenditure, this is the highest proportion ever recorded. While it is perhaps unfair to focus on the charges incurred this year as price assumptions were adjusted down, a longer-term perspective highlights a lack of capital discipline. In fact, from 2010 to 2015, the top 40 have impaired the equivalent of a staggering 32 per cent of their capex incurred.
During the mining boom, in an effort to continually increase production, mining companies undertook expansion strategies that included unrestrained capital spending programs and high-priced mergers and acquisitions. Often, a disciplined capital allocation approach was lacking and this exposed many companies to significant write-downs when commodity prices inevitably subsided from their historic highs. Glencore, Vale, Freeport and Anglo American have arguably been the hardest hit, with impairments totalling nearly $36 billion, or 68 per cent of the total impairment recorded across the top 40.
Investors will not be surprised by the continued decline in capital expenditure. In fact, they have demanded it. Less welcome is the acceleration in impairments relative to capex. Such value destruction has not gone unnoticed and has contributed to the ongoing negative sentiment.
The past year has certainly seen a sustained deterioration in the viability of the top 40. Even during the global financial crisis, the liquidity crunch was quickly solved through a combination of rights issues and a sharp rally in commodity prices. Cheap and readily available debt was used to fund investment programs. However, with the softening market, today’s earnings are not always sufficient to provide absolute confidence that the borrowings will be repaid when they become due.
Accordingly, debt management has risen up the agenda of many of the top 40. For some, the driver was maintaining access to capital at reasonable rates. For others, it was simply crucial to survival. The top 40 trimmed total debt by $10 billion, or three per cent, in 2015. Despite this, net debt remained stagnant and liquidity metrics have begun to trigger some alarms.
Short-term borrowings, requiring repayment within 12 months, have increased by nine per cent to $48 billion. The change in maturity profiles was starkest among emerging companies, where short-term borrowings increased from 16 per cent of total debt in 2014 to 22 per cent in 2015.
While the top 40 may have been comfortable with their level of borrowings at the start of the year, their perceived ability to service this debt came into sharp focus during the year as their earnings deteriorated. The key net debt to earnings before interest, taxes, depreciation and amortisation (EBITDA) ratio, often a covenant applied by lenders, rose by 62 per cent, from 1.52 to 2.46, between 2014 and 2015. Alarmingly, 12 of the top 40 have a net debt to EBITDA ratio above four. This figure is a staggering increase from the previous year, when only four companies had such a high ratio.
It is perhaps no surprise that credit rating agencies announced a series of credit downgrades in 2015. Some companies, including Anglo American and Vale, were even relegated to below investment grade.
The top 40’s response has been twofold:
- an even greater focus on cutting expenditure, whether operational or expansionary
- an acceleration in asset sales.
Until now, non-core asset sales volumes have been subdued as buyers and sellers contemplated the value expectations gap. However, the pressing need for miners to monetise assets is changing this dynamic. Combined with speculation that the bottom may have been reached, the scene has been set for a large increase in deals, which we expect will eclipse the $14 billion of disposals realised in 2015. The question remains whether coveted tier-one assets and/or less marginal assets may change hands. What is clear is that the need to monetise assets now has increased the top 40’s appetite to consider all options, as evidenced by the recent streaming deal announcements.
Coal and lithium: contrasting stories
Of all commodities, thermal coal has been the most maligned over the past year. One would be hard pressed to find a near-term prognosis of prosperity anywhere within the mining and energy sectors. Although the emerging economies, particularly the Indian subcontinent and South-East Asia, may drive future import demand, it is highly unlikely that they will replace the unprecedented demand from China witnessed over the past decade.
Although China’s waning demand has occupied the spotlight, it is one component of a broader social and geopolitical trend that has been referred to by some as a ‘war on coal’. Some major banks are no longer financing coal-fired power plants; historical stalwarts of the United States coal industry Peabody Inc and Arch Coal both filed for bankruptcy in 2015; coal production in the United States fell 39 per cent from early April 2015 to April 2016; and divestment has become a running theme in the coal narrative just as closure and cleaner technology had been in the power sector.
Coal has also been under pressure owing to technological advancements and the reduced costs of less carbon-intensive energy sources, particularly renewables and liquefied natural gas. Solar installations and solar adoption have moved at a pace faster than many predicted as a result of reduced costs and improved battery storage. These developments offer new opportunities and markets for mining companies that can adapt to the changing energy mix.
Nevertheless, in the short and medium term, coal remains the most inexpensive energy source that we have, and there are 1.2 billion people on Earth without access to electricity. Although the movement to ‘phase out’ coal is real, the commodity will continue to play a critical and significant role in the energy mix of many economies.
While coal’s fortunes have been less than optimal, lithium has been the darling of investors, with prices effectively doubling over the past six months. Lithium has experienced unprecedented demand over the past year due to its widespread application in batteries. A key component of this is a widely anticipated shift from fossil fuel-based cars to electric vehicles over the next decade.
Deutsche Bank now forecasts that the global lithium supply market will triple over the next ten years. Large corporate actors, particularly in the electric vehicle market, are designing their products around lithium-ion technology and this will not change overnight. Lithium’s long-term demand remains to be seen as other technologies requiring new metals could replace lithium at the top of the commodity podium. However, in the near term, the oversupply scenario can’t be ignored. As seen over the course of this article, speculation often overshoots demand, and lithium may not be an exception as miners shift rapidly into the South American market and Deutsche Bank forecasts supply tripling over the next ten years.
Falling market capitalisations and net losses have left the world’s top 40 mining companies in perhaps their most precarious position according to PwC’s recently released Mine 2016 report. Some are in a fight for survival. However, while the industry continues to face significant market challenges and constraints, the outlook still remains strong over the longer term. With the trend towards urbanisation set to continue in the future, rewards are likely to flow to those that are patient and take a long-term view.
About Mine 2016
PwC uses the top 40 companies by market capitalisation at 31 December 2015 as a proxy for the performance of the mining industry.
Changes to the top 40 this year include:
- four new entrants, all of which are Chinese companies: Shaanxi Coal, Sichuan Tianqi, Tongling and Zhongjin Lingnan
- Fresnillo has been included instead of Penoles (due to Fresnillo having a larger market cap and the avoidance of double counting)
- AngloGold Ashanti has re-emerged in the top 40 for the first time since 2013.
- Notable changes in the composition of the top 40 include:
- The number of Chinese companies has risen from nine to 12 (even though one Chinese company dropped out from last year).
Notable absentees from the top 40 include First Quantum and Teck Resources. Previous top 40 companies Gold Fields and Kinross again failed to regain top 40 status
The market capitalisation threshold for attaining top 40 status remained consistent at $4.5 billion. This is surprising given the huge decreases in value of the top mining companies, but demonstrates that the new entrants are catching up.
The number of emerging companies included in the top 40 has increased by two and now totals 19. There is now an almost even split between the emerging and traditional companies in the top 40.
PwC’s Mine 2016 report is available from www.pwc.com.au/mine-2016.
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