Unshackled: will mining capital flow more freely in 2017?
For five years mining companies have been hard pressed to maintain liquidity. But could the capital constraints be loosened in 2017? Nnamdi Anyadike investigates.
It is beyond question that the global mining industry has taken a severe hit on the back of the economic downturn. The consequent sharp drop in demand for raw materials from the key Asian economies, led by China, has led to a whole swathe of mining and resource companies pruning their commitments in a bid to cut costs. Anglo American, Nyrstar, Freeport-McMoRan and Glencore have all announced their intention to divest assets in a bid to remain liquid.
Australia is one of the biggest players in the global iron ore and coal mining industry, but in its latest Investment Monitor, advisory firm Deloitte Access Economics reports that despite the rebound in iron ore prices this year, investment in Australia’s resource sector is likely to be sparse.
“Not a single iron ore project is currently under construction,” the report notes. And Australia’s coking and thermal coal is likely to share the same fate.
To compound the mining industry’s woes, companies are being forced to deal with a capital access squeeze.Ernst & Young's (EY) global mining & metals transactions leader Lee Downham says in a recent report that overall, capital raised across the global mining sector has been down by about 10% year-on-year since 2010. The decrease was primarily due to a sharp drop-off in capital raised, loan finance to the sector and completed initial public offerings (IPOs).
Between 2014 and 2015, capital raised fell by 9% to $228bn and loan proceeds were down by 27%, to $122bn. And although thirteen IPOs were completed last year these were done with a 78% drop value from the previous year. “Gone are the megadeals with the unashamed focus on consolidating market share,” says the report.
At its 2007 peak, over $200bn of deal value were done across the sector. Today, these high value deals appear to be a thing of the past. Instead, the focus is on higher returns on capital, greater optionality and flexibility across asset portfolios.
The ‘sell-side’ is likely to continue to be the catalyst for mergers and acquisition (M&As) and private capital may well be the new face of M&A activity across the sector. Joint ventures and mergers of equals have also grown in popularity and EY expects to see this trend continue into 2017. If managed well, joint venture agreements can deliver value to stakeholders by improving the value of portfolios. They can also open hitherto untapped access to reserves and capabilities.
The need for increased cyber security and technology in the mining industry is one of the drivers for consolidation. EY sees innovation as a key enabler of productivity improvement as well as being a provider of a competitive edge. It believes mining companies should look at and collaborate on innovation with other companies within the sector, other sectors, service companies and academic institutions.
Have we reached rock bottom?
But despite the gloom this year there are signs that the bottom of the mining and resource cycle has perhaps been reached and an upturn is on its way. At the end of October, the World Bank increased its 2017 price outlook for both metals and oil from its July forecast. This should have major implications for the mining and minerals sector’s ability to access finance.
The World Bank projects a rise in energy prices, including oil, natural gas and coal, of almost 25%. Metal prices are now projected to increase by 4% as most markets continue to rebalance. The largest gain is for zinc, which is projected to rise more than 20% on continued supply tightening from large mine closures. These expected rises follow on from the price increases witnessed in the second half of this year. In the third quarter, metal prices rose by 4%, marking the second consecutive quarterly gain. Iron ore, nickel, tin and zinc rose by more than 20% over the past two quarters. Meanwhile, the two largest consumed metals - aluminium and copper - saw more modest gains in late 2016 on ample supply and rising capacity.
2017: a potential market rebound
The value of global mining and metals deals in 2017, though, are likely to hold back the overall pick-up in the mining sector, at least in the first half of the year. At the end of 2016, strength had yet to return to the deal market. Global mining and metals M&A activity remained subdued in the third quarter with deal values flat at $7.9bn.
Deal volumes, though, were up by 12% with China being the highest value deal-maker during the period. The Asian giant was the target of $2.4bn worth of mining transactions and the acquirer of $3.8bn worth of transactions. This represented 29% and 48% of respective global totals. China Molybdenum’s $1.5bn acquisition of Anglo American’s niobium and phosphate assets in Brazil played a significant part in the overall total.
While some in the industry decry the low value of the current crop of M&A deals, Downham argues that the continuing fall in M&A deal value may not necessarily be a bad thing, or indeed an accurate pointer to the state of the market. This is because the priority for miners is portfolio realignment rather than acquisitions for future growth. And it is this divestment strategy that is driving activity rather than a rush to consolidate, as was the case at the last peak.
Cash is king
However, things could well be about to change. Looking forward, a number of mergers on the horizon may herald a return to high value deals. These include the merger between Potash Corp. of Saskatchewan and Agrium, and the restructuring deal between Baosteel Group and Wuhan Iron & Steel Group, says Downham.
Meanwhile, cash optimisation and capital access are identified as the top two business risks facing the mining and metals industry in 2016-2017.
With regards to cash optimisation, market volatility, the unpredictable and neverending shifting of commodity prices has – and still is - creating uncertainty. Despite the ability of miners to hedge on, for example, the London Metal Exchange (LME), there remains a limited visibility of pricing and demand going forward. Cash is king, though, and companies that are reluctant to risk their balance sheets are managing their liquidity through sustainable cost reductions. This is aided and abetted by the actions of banks who are only offering financing to mining companies that can guarantee the security to back the debt.
If the market improves next year, the focus could well be on increasing working capital and improving that capital’s effectiveness. Commodity prices often dictate a mining company’s outlook on the future. What will be important to any given mining company, at least as much as cutting costs to survive, will be how it positions itself against its competitors.
As EY points out, realising capital is only the first step. The next step is for a company to use that capital wisely to support future growth opportunities.