Small Miners Against the Big Crunch

8 December 2008 (Last Updated May 31st, 2018 16:41)

Without access to cash and a way to diversify their portfolios, the future for junior minors is looking increasingly difficult. Gavin Knight reports.

Small Miners Against the Big Crunch

The mining industry has been hit hard by the falling price of commodities and the lack of credit. While mining giants such as BHP Billiton, Rio Tinto and Anglo-American will remain robust, it is the smaller, junior miners who risk withering away or being taken over.

As with other sectors of the economy, access to cash is crucial. "Cash is becoming king – so those miners who can get and use cash are in a strong position," says Jonathan Lambert, director at PriceWaterhouseCoopers (PWC) in London. "It is a cash-intensive business and 2008 is proving a very difficult year to raise finance.

"While mining giants such as BHP Billiton, Rio Tinto and Anglo-American will remain robust, it is the smaller, junior miners who risk withering away or being taken over."

"Traditionally they would raise finance by listing on AIM [Alternative Investment Market] and moving up the board, but due to a weakened financial position their share prices have fallen." The industry is cash-intensive not least because the equipment in mining is very expensive. Lambert, who specialises in the sector, says that there have already been a lot of cancellations of equipment orders.

In early December, PWC published a report on junior miners to coincide with the Mines and Money Conference in London. "If you look at the background to this, in 2007, of the top 50 AIM mining companies listed on the main board, eight were acquired and 13 reported no revenue.

"[Overall] there was an 81% increase in revenue due to the rise of commodity prices; but despite this, profitability decreased. 2008 started on a high as these companies were using their existing cash resources. [But] a lot of internal funds had been used, so they did not have cash to expand."

Lambert says that the market capitalisation for AIM in 2007 was £11.8bn at the end of December 2007 but by the end of October 2008 it had fallen to just £3.2bn. Junior miners are therefore taking steps to ensure they appear more profitable despite the difficultly of securing extra financing by the end of the year.

Keeping up appearances

Although the sector faces many challenges related to plummeting commodity prices, there is still a demand for mined produce.

"In the past there has been a lot of demand and lots of labour constraints," Lambert says.

"It was at an unprecedented high and although it has slowed, it has not stopped."

Companies also face the challenge of retaining key specialists.

"The best people will go to the companies that pay the most money," adds Lambert.

"If you have a proven resource, this means you know that there is commodity in the ground and you just need to get the equipment in to get it out."

The impact of global economic conditions on a junior miner can be seen at one of the most famous mining locations; Broken Hill, in Australia. Zinc miner CBH resources has slashed staff levels at its Endeavour mine in Broken Hill just two months after a previous round of redundancies.

In addition, Consolidated Minerals cut staff from its exploration and geology fields and Poseidon Nickel, Newcrest Mining, Mt Gibson Iron and nickel miner Minara Resources have also had to cut back their
workforces.

The situation does not look good at Broken Hill; earlier this year CBH found zinc prices had dropped below operating costs. In response, it plans to reduce production from 940,000t to 658,000t. In April 2008, CBH announced its intention to acquire another junior miner, Perilya.

The proposed merger would mean that the Broken Hill line of lode had a single owner for the first time in 130 years. However, by the end of 2008, Perilya’s share price had dropped to such an extent that CBH expressed concerns over the deal.

This scenario of a falling share price being a barrier, as opposed to an incentive, to making an acquisition is a question of timing and a similar scenario is being played out in Russia.

UC Rusal, the world’s largest producer of aluminium, controlled by billionaire Oleg Deripaska, secured a $4.5bn loan in April 2008 to buy 25% of Norilsk Nickel, one of the world’s leading producers of nickel and palladium. The loan, however, was secured against Norilsk’s share value, which then went on to lose more than 80% of its value after the deal was agreed.

Despite these examples, there is likely to be consolidation in the industry due to individual companies’ inability to raise cash.

"Some companies have very good assets but can’t raise cash, this will make them very good targets," explains Lambert.

"Lots of the balance dates for banks are at the end of this year and the banks don’t want to put any risk on their balance sheets. Companies need to focus on cash flow. It will take some time for the debt market to recover."

Lambert is keen to stress the difference in future potential between producers and non-producers, or in other words, those companies who possess strong assets and those that do not. "If you have a proven resource, this means you know that there is commodity in the ground and you just need to get the equipment in to get it out. In general, share prices have fallen to a level below net asset value and in some cases below their cash flow. So if have cash you are in strong position. The diversified miners still have cash."

Diversification is king

Diversified mining companies should be the ones likely to make acquisitions. However, there is a wait-and-see philosophy as the danger of falling share prices fuels doubts.

For companies producing different commodities across different continents, diversification is the key. Anglo-American is diversified through 60 countries, mining many different commodities from base and ferrous metals to industrial minerals and gold, diamonds and platinum.

In terms of financing, Anglo-American has been buoyed by the Chinese economic stimulus package. This is because China is responsible for 55% of iron ore seaborne consumption, 40% of coking coal, 38% of carbon steel and 35% of aluminium. China Development Bank is also one of the company’s shareholders.

One metal that is bucking the trend and is often seen as a safer asset in times of crisis is, of course, gold. But in South Africa, the second biggest producer of gold after China, production has dropped dramatically and is down around 17% year-on-year in recent months.

Around 40% of the world's gold reserves are still to be found in the Witwatersrand basin, South Africa, where leading gold producer, Harmony Gold, has its operations. The third quarter was very difficult for Harmony as it battled with escalating costs, particularly rising electricity costs and winter tariffs.

"For companies producing different commodities across different continents, diversification is the key."

Meanwhile, Barrick Gold Corp reported September net income of $254m compared with $345m in the corresponding 2007 period. At the same time, Gold Fields Ltd's earnings fell 91% to $4m.

But when compared to other commodities, gold has still done well.

"When there are troubles in the financial markets then gold is a good place to be," said Graham Briggs, Harmony Gold’s CEO, on Summit TV.

"Gold is a store of wealth and we believe it is going to be better in the future. The mid- to long-term price is $900 per ounce so we are quite optimistic."

Briggs’ optimism is borne out in the financials. The average annual gold price improved to $818 per ounce while, despite the challenges, group revenue rose 15% to R9.21bn. Harmony produced 1.55 million ounces of gold and also advanced a number of projects in Tshepong, Doornkop, Phakisa and Elandsrand. In terms of international stature, the company’s expanded exploration portfolio has focussed on Papua New Guinea including the Wafi-Golpu project, a gold-copper deposit, and Kalgold, a gold-silver deposit with production set to start in 2009 on a mine with a projected life of 14 years.

However, Briggs reiterated PWC’s Lambert’s concerns over juniors’ inability to raise cash.

Juniors and exploration companies are not able to raise money to explore," he said.

"That of course means that there are a lot of acquisition opportunities in the market. There are a lot of companies under stress because they can’t raise money to do what they want to do."

Vince Borg, a spokesperson for Barrick Gold, echoes the challenges facing juniors, namely the access to cash, "They cannot tap into the equity or credit markets," he warns, saying their best strategies are to 'cut costs across the board and defer capital investments'.