(As originally published on LinkedIn, 20 July 2017)

Does cutting debt have to mean reducing your ambitions?

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By: Michelle Grant, EY Canada’s BC Mining & Metals Transaction Advisory Services leader

In June, EY released a report that addressed the question, Does cutting debt have to mean reducing your ambitions? The first report in a series focused on the mining industry’s capital agenda, EY reviewed the top 50 mining companies by market capitalization in 2016. We found that the sector is in far better health than investors think.

So back to the question: does cutting debt have to mean reducing your ambitions?

From my perspective the short answer is no, cutting debt doesn’t have to mean reducing your ambitions. But companies need to be cautious. Each company has an optimal capital structure, and swinging the pendulum too far one way creates issues. If the cuts are too deep, companies run the real risk of letting debt levels fall too lows that create inefficient balance sheets. They may also miss out on funding necessary investments in projects that will generate returns down the road.

How do miners tackle leverage?

According to our report, a relentless focus on balance-sheet strength and productivity, supported by a recovery in commodity prices, led to a 17% reduction in net debt among the top 50 mining companies we surveyed.

Debt reduction was driven by proceeds from asset sales, capital expenditure curtailment and dividend suspension, allowing the sector to be less exposed to tighter lending criteria by financial institutions.

Did financing costs peak in 2016?

Financing costs increased significantly at the beginning of 2016 due to poor credit ratings and a negative outlook for the sector. Consequently, miners in most regions of the world faced great difficulty in accessing conventional capital.

Expenses increased in 2016 despite falling proceeds, highlighting the rising cost of capital in the industry.

Borrowings were mainly used to finance the rise in working capital and refinance existing facilities. While working capital performance has improved significantly in recent years, it continues to be a key focus area. Effective programs to manage working capital provide companies with more flexibility to sustain operations from existing cash flow, avoiding the need for short-term borrowings.

What’s next for the sector?

The sector is not out of the woods yet, with continued volatility expected across most metals and strong pricing in iron ore and met coal, in particular expected to soften.

For now, capital discipline remains the focus with limited appetite for mergers and acquisitions or capital investment in anything but low-risk projects. If there is a lack of investment, balance sheets will become inefficient and the sector could fail to generate appropriate returns in the future.