The mining sector has experienced a decline in deal activity for the fifth consecutive year due to uncertainty over long-term fundamentals and increasing levels of financial distress.
This distress may be the precursor to recovery in deal volumes — if not value — during 2016 says a new report by EY which below summarises the financial stability in the sector over 2015 and looks into potential ways foward.
[quote]Management across all levels of the mining and metals sector continue to focus on balance sheet and margin improvement.
Organisations have embraced capital expenditure cuts, mothballing of loss-making operations, productivity improvement and working capital efficiency drives. However, in this market, even these actions are not always sufficient.
With internal options exhausted, management are having to make strategic decisions that have long-term implications on the future direction of the business, such as:
- Corporate restructure
- Dividend cuts
Shareholders are increasingly influencing the agenda
Many of the actions witnessed during 2015 are likely to be replicated in 2016 with, arguably, greater regularity and scale.
It is increasingly clear that position on the cost curve is critical as supply-side correction looks to be the only way to restore fortunes. However, with so much uncertainty linked to finance-backed commodity trades, the supply-demand picture is arguably less clear than ever.
As a result, the supply-side correction is coming; the question is how much of it will be voluntary shutdowns? And how much will be forced via corporate failures?
The starkest realisation of 2015 is that nobody is sure how long the current downturn is going to persist and management cannot sit back and wait for an improvement in market conditions.
Investors are increasingly short of patience, as the dramatic fall in share prices in 2015 demonstrated. There is also an increase in the level of activity from activist shareholders, such as Casablanca (Cliffs Resources) and Carl Icahn (Freeport-McMoRan) who have a track record of instigating change at both the management and the operational levels.
Unless equity prices begin to pick up, which seems unlikely in the short term, these investors will continue to circle the industry looking for opportunities to stimulate change and drive value out of challenging situations.
Capital raising continues to be an issue
Overall, capital raised across the sector was down by about 10% y-o-y. The decrease was primarily due to a sharp drop-off in loan finance to the sector, which fell to US$44 billion in 2015 from $122 billion in 2014.
Much of this was for the refinancing of existing facilities, emphasising the limited amount of new finance going into projects. However, this trend comes as no surprise given the very difficult — and worsening — trading environment that the industry faced during 2015.
The backdrop of challenging market conditions has led to a number of alternative financing strategies being pursued, with asset disposals featuring prominently and almost $3 billion of streaming finance being announced across the industry.
2016 outlook for the mining sector
Gone are the mega deals with the unashamed focus on consolidating market share says EY. At its 2007 peak, we saw over $200 billion of deal value across the sector, with a small number of proposed deals at the time valued well in excess of $70 billion.
This deal rationale has limited currency in the sector right now; size is not all-important, but instead the focus is on higher returns on capital, greater optionality and flexibility across asset portfolios, and an improved cost curve position.
Key M&A trends that EY sees continuing into 2016
- Private capital
- Deferred consideration
- Joint ventures and mergers of equals
Capital raising in 2016
The financing markets are expected to remain challenging in the year ahead, with corporate rating agencies taking a very close look at future cash generation and corporate refinancing strategies.
The availability of equity will remain an option of last resort only and will be highly dilutive to those looking to raise secondary equity.
Now would appear to be the time for well-capitalised producers to look at lending opportunities into the sector that position them for future strategic growth and alternative finance providers to evaluate the opportunities in distress.
World-class assets trapped in difficult corporate situations may still provide strong financial returns to the canny investor.