After two years of improving financial performance, reduced debts and cost-cutting, the next phase in the mining landscape will involve the incorporation of advanced technology.
This will further enhance efficiency, the increase of environmental sustainability and transparency of operations, and the shift away from legacy commodities by investing in commodities of the future.
Submitted by BMI Research – a unit of the Fitch Group
Core objectives of miners will still be the containment of costs, debt reduction, restrain over supply and streamlining of operations to focus on core strengths.
Mining companies have enjoyed a return to good performance since the 2016 financial year and they are now better positioned to weather storms, grow further and reap significant profits for their investors.
Following on from FY2016, results from FY2017 and Q118 show miners’ improving incomes, cash flows and reduced debts.
Since the commodities rout that saw prices bottoming in 2015, miners have vastly streamlined their operations, cut costs and expenditures, and increased production efficiencies.
As further gains in these aspects become harder to achieve through traditional means, the challenges looking forward will encompass the incorporation of advanced technology in mining operations to further enhance productivity and reduce costs, the increasing pressures to increase transparency in operations and environmental sustainability, and the shift away from legacy commodities to invest in commodities of the future.
Debt reduction still core
FY2017 saw major miners reduce debts further, and we believe this will remain a core priority of mining companies going forward.
Years of divesting from non-core assets and implementing stringent spending programmes has allowed firms to significantly reduce debt-loads: Anglo American’s drastic restructuring plan announced in 2015 lowered the firm’s total debt-to-EBITDA ratio from a staggering 22.8 x in 2012 to 1.5x by 2017.
While Anglo moved away from the initial plan to whittle down its portfolio to exclusively copper, diamonds and platinum, the firm s till shed 32 assets (from 68 in 2013) over the past four years and continues to offload high-cost mines.
In Q1,2018, Anglo completed the sale of the Drayton coal mine in Australia and several thermal coal operations in South Africa.
Vale also made big strides in reducing its heavy debt load from over US$24.5 billion in FY2016 down to $18.1 billion as of FY2017, supported by the sale of the company’s fertilizer business to The Mosaic Company for $1.4 billion in Q417 and improved cash flow.
Rio Tinto also managed to reduce net debt by 61% y-o-y to $3.6 billion in FY2017.
Glencore continues to lower its debt-load, with net debt reduced to $10.7 billion in FY2017 compared to $15.5 billion in FY2016.
The company’s debt to EBITDA ratio is at a multi-year low of 2.7x.
In 2015, Glencore made the headlines in the news due to elevated debt levels of $30 billion and cancellation of dividends that caused investor panic and a share-price collapse.
Thus far the company has been successful at reigning in debt, thanks to a combination of the recovery in commodities prices and better governance.
Pursing capital discipline despite tempting times
Times are tempting for miners to resume aggressive acquisitions amidst better performance and a pickup in commodities prices since 2017.
However, despite better performance and improving cash flows, mining companies are showing signs they will continue restrain over capital and supply over the coming quarters.
While healthier balance sheets have encouraged as light increase in capex budgets of miners since 20 17, the increase has been modest.
For instance, Anglo American plans on a $2.6-2.8 billion capital spending in 2018 compared to $2.4 billion in 2017.
Similarly, in FY2017, Glencore spent $4.2 billion on capex and for 2018-2020, and aims a yearly $3.3 billion of sustaining capex and $1.2 billion of expansionary capex.
This will ensure miners have greater free cash flows going forward to weather market volatility better than in past years.
Going forward, capex for most miners will mostly be spent on sustaining existing operations, innovation to improve operational efficiency, and expanding growth assets as minimal investment in greenfield projects will continue.
Miners will also remain disciplined in terms of production, in order not to repeat the mistakes of the 2004-2013 commodity boom years.
While prices of most commodities will fare better over the years, we expect miners to hold the reigns on supply.
For instance, Rio Tinto has adopted a ‘value over volume’ approach and expects minimal increases in production in 2018.
Anglo American will roughly maintain production of all its commodities at 2016 levels except for diamonds.
Need to cap costs increasingly crucial
Cost inflation related to higher commodity prices will become a larger challenge for miners in the coming quarters as key EM currencies continue to strengthen, oil prices rise and governments look to increase revenues from a recovering industry.
Whereas the spike in metal prices largely offset these effects in 2017, we expect more muted price gains in 2018, meaning that rising costs will have a larger negative impact on profits.
Building on their recovery in 2016, top mining companies cited cost savings and efficiency gains as key reasons behind the earnings improvements in FY2017 that for instance, saw Rio Tinto’s larges t-ever dividend of $5.2 billion, and Anglo American’s highest dividend in a decade of $1 billion.
Anglo achieved cos t and volume improvements of $1.1billion–more than target in FY2017.
The company is targeting an additional $3-4 billion annual underlying EBITDA run-rate improvement by 2022.
In Q118, Freeport also reported lower y-o-y average unit net cash costs of $0.98/lb of copper.
However, cash costs at the firm’s North American operations increased due to higher repair and maintenance costs and cash costs rose at the firm’s South American operations due to higher mining rates and lower ore grades.
Mitigating currency risk imperative for future earnings stability
Fluctuating currencies will pose significant risks to miners in the coming decade.
Most major mining countries in Latin America, except for Brazil will see their real exchange rates appreciating in the coming decade, to the woes of mining companies operating in the region.
Apart from Brazil, these very countries offered miners significant cost savings in previous years as their currencies followed a depreciating track.
Major miners operating in Peru, Chile and Mexico, including Vale, Anglo American, Alcoa, ArcelorMittal, Codelco, BHP, Glencore, and Rio Tinto will be affected.
Anglo American’s policy is generally not to hedge such exposure given the correlation, over the longer term, with commodity prices and the diversified nature of the group.
The prices of commodities have historically tended to drop when the dollar strengthens against other major currencies and vice versa.
In the case of BHP, as a portion of the group’s debt is denominated in currencies other than US dollars, the group uses cross currency interest rate swaps to mitigate currency exposure.
Major Asian mining countries, with the exception of Australia, China and India, including Indonesia, the Philippines, Malaysia and Mongolia will see their real effective exchange rates appreciate against the US dollar in the years ahead.
Major miners operating in these countries include Freeport-McMoRan Inc, Newcrest Mining, Rio Tinto and Nickel Asia Corp.
In the case of Rio Tinto, a depreciating Australian dollar helps reduce costs relative to revenue, but also leads to losses in equity as assets in Australia are valued less.
Like most miners, Rio Tinto does not hedge against currency risk under normal circumstances.
Nevertheless, the group reviews its exposure on a regular basis and reserves the right to enter hedges to maintain financial stability.
Currency protection measures are undertaken in specific commercial circumstances, typically hedging of capital expenditures and other significant financial items such as acquisitions, disposals, tax and dividends, and are subject to strict limits laid down by the board.
The biggest benefactors in Africa will be mining companies operating in Guinea, Senegal, Mauritania, Cote d’Ivoire and Zambia as these countries will see the biggest declines in their currency.
Although at a much milder rate, South Africa’s currency will also depreciate against the US dollar in a 10-year horizon.
Key Chinese miners also operate in these countries, such as Zijin Mining Group, Jinchuan Group and China Molybdenum.
On the other hand, African states such as Tanzania, Mozambique, Botswana and Ghana’s appreciating currencies will not add to any cost savings for miners operating in these countries but may increase equity as the value of their assets will increase.
Improving environmental reputation, transparency to become necessary
The rapidly growing electric vehicle (EV) sector, underpinned by lithium-ion batteries, and consumer electronics sector will become increasingly valuable customers for top metal and mining companies, leading to rising pressure to reduce environmental impact and improve transparency in the industry.
Top automakers looking to expand electric vehicle fleets will boost demand for metals including lithium, nickel, cobalt and aluminium, through various cathode chemistries.
Copper will also see a boost from EVs, as the conventional internal combustion engine used in motor vehicles typically contains about 20 kg of copper compared to 80 kg used in EVs.
As metal prices continue to rise, companies will have more financial flexibility to invest in initiatives, primarily through technology advances, to adhere to rising global standards for environmental and social impact.
Already, key deals between metal producers and EV or consumer electronics firms reflect the trend toward environmental sustainability and social accountability in the metals and mining industry.
In May, US electronics firm Apple and top aluminium producers Rio Tinto and Alcoa announced plans to invest in carbon-free aluminium through joint-venture Elysis.
Along with the Canadian and Quebec governments, the firms will invest CAD188 million in the venture.
In February, a group of Chinese buyers of Congolese cobalt reportedly formed the ‘Responsible Cobalt Initiative’, along with major companies including Apple, Samsung and most recently carmaker Daimler.
The programme will attempt to us e blockchain technology to ensure child labour was not used to produce the material, a widespread issue at artisanal cobalt mines in the DRC.
In January, BMW and top Chilean copper miner Codelco announced the ‘Responsible Copper Initiative’, aimed at improving the commitment to ecological and social responsibility in the copper industry.
In 2017, BMW purchased 42 kt of copper and expects this figure to increase by 20 kt by 2025 as EVs are rolled out.
Investing in technology key priority for further efficiency gains
Mining capital expenditure will increasingly target advanced technology that enables further efficiency gains, as industry leaders prioritise technology to remain competitive and better withstand price volatility.
The acceleration of technological integration in the mining industry will widen the gap between the top low-cost producers and junior miners, as well as improve the competitiveness of developed markets compared to underdeveloped.
Following years of under-investment during the commodity price downturn, firms with older mines will require additional spending to extend the profitability of asset portfolios.
For instance, Rio Tinto, a leader in integrating advanced technology into operations, saw the average age of assets increase from 8.9 years in 2011 to 13.4 years by 2017.
Investing in technology can help realise further profits and extend mine lifespans, such as through augmented reality that allows miners to safely explore deeper, high-grade deposits at mines facing declining ore grades.
Renewed focus on core commodities
Refocusing on core mineral segments and streamlining business operations will remain a theme among top miners looking to regain investor confidence.
For instance, Freeport McMoRan, which exited the oil and gas business in 2016 following an investor campaign, has returned to prioritising its core copper assets, focusing on negotiations to maintain production at the Grasberg mine in Indonesia, developing the $850 million Lone Star copper project in Arizona and evaluating expansion plans at the El Abra mine in Chile.
On the other hand, facing declining iron ore prices over the long-term, top Brazilian miner Vale will look to reduce its reliance on the s egment, which accounted for 86% of adjusted EBITDA in 2017.
Vale, which also produces copper and nickel, plans to increase the share of its base metal segment to account for at least 30% of earnings by 2019, by lowering operating costs and evaluating strategic acquisitions.
The firm’s net debt also remains elevated compared to peers, at $18.1 million as of December 2017, due to continued spending over the commodity price downturn to bring the multi-billion-dollar S11D iron ore project online.
Miners to increasingly invest in commodities of the future
In the longer term and beyond, as future gains for mining companies become harder to come by after cos t and debt reduction reach their limits, these companies will look towards other areas to grow and create shareholder value.
They will increasingly look to invest in commodities of the future and less in legacy commodities, an approach that will encourage organic and acquisitive investment in new mineral sectors.
Miners will increasingly invest in minerals required in modern technological applications such as cobalt, lithium (used in rechargeable batteries) and copper (used in electric vehicles) or those that are consumer-oriented such as diamonds and platinum.
In that respect, Anglo American will find itself better positioned as the company has a greater exposure to commodities like platinum and diamonds, which account for about half of revenue.
These commodities will enjoy better demand growth from China than infrastructure-oriented commodities including iron ore and steel that prospered most in the past decade.
Already ahead of peers, Glencore completed several transactions over 2017, most notably purchasing the remaining stakes in the Mutanda and Katanga copper-cobalt mines in the DRC for $922 million and $38 million, respectively, acquiring a 49% stake in the Hunter Valley coal operations in Australia from Yancoal for $1.1 billion in cash, and increasing its stake in Peruvian miner Volcan Compania Minera to 23.3% for $734 million.
Glencore’s growth strategy reflects the industry theme of favouring partnerships and brownfield investment over riskier new projects, however the firm diverges with peers regarding coal.
While other major miners are exiting the coal market in response to a global shift away from emissions-heavy power sources, Glencore will continue to provide cheap energy to the developing world.