Does cutting debt have to mean reducing your ambitions?

By

Lee Downham

EY Global Mining & Metals Transaction Advisory Leader

Advising on transactions for EY Mining and Metals clients since 2004. Focused on buy-side and sell-side due diligence and public market listings.

5 minute read 11 Apr 2019

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For mining and metals, reducing debt and growing your business is a balancing act of cash, costs and capital discipline.

The mining and metals sector has to search for long-term strategies to drive competitive and sustainable shareholder returns. Depending on their strengths, companies can find ways to grow production volumes and optimally reconfigure assets within their portfolios.

In recent research, we have explored ways to do this – both in terms of satisfying stakeholder demand and in managing working capital and debt.

A balanced approach to capital allocation, which considers not only the need to return cash to shareholders but also the need to grow, is necessary to enhance shareholder value creation.

Using the top 50 global miners as a gauge on the industry’s health, we conclude that focus remains on reducing financial risk. However, there is a need to innovate strategies to satisfy shareholder return demands as shareholder value creation has consistently eroded since 2011.

Some highlights:

  • Capital structure for the sector continues to change. Gearing dropped to 32% at the end of 1H17 for the top 50 miners, 2 percentage points lower than that at the start of the year.
  • Total Shareholder Returns (TSR) has seen a positive rebound since 2016 as equity appreciated, but in 2017, TSR will be driven by the return of dividends and share buybacks.
  • Economic value creation has consistently eroded across the industry since 2011, even in 2016.
does cutting debt have to mean reducing your ambitions graphic
does cutting debt have to mean reducing your ambitions graphic

3 strategies for sustaining shareholder value creation

To sustain value creation and meet shareholder expectations on return, miners increasingly have to shift from a short-term focus on cash to a long-term strategic plan for capital that delivers returns across the portfolio. These are:

1. Production growth: companies can look to add production levels by expanding existing operations or bringing new mines on line; however, quality of assets has to be extremely good for the volume growth to be effective. Acquisitive growth is another avenue, but it’s important to identify the best projects to invest in, from both a quality and a portfolio-fit point of view.

2. Portfolio optimization: the divergence of commodity markets and increased volatility require mining companies to maintain a balanced portfolio that is able to cushion against unexpected adverse price movements.

3. Balanced capital allocation: as the market shifts to growth, measures for better capital allocation, which consider the need to reward shareholders and productivity growth, will be crucial for future standout performers.

As the market shifts to growth, measures for better capital allocation will be crucial for future standout performers.
does cutting debt have to mean reducing your ambitions graphic

Debt in mining

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 in 2016. Debt levels in had crept upward, leading to record levels of leverage into 2015.

Gearing came down significantly in 2016 as companies focused on debt reduction. At the same time, improving market fundamentals led to gains in miners’ valuations. Gearing dropped to 34% for the top 50 miners, back at levels last seen in 2013.

does cutting debt have to mean reducing your ambitions graphic

Working capital in mining

Working capital performance has improved significantly in recent years. As expected, however, the rebound in activity in 2016 led to an overall rise in working capital investment during the year.

Key initiatives to reduce working capital commitments have considered a wide array of items, including:

  • Efficient raw material sourcing to improving demand forecasts and enhancing supply chain planning
  • Deploying lean and agile manufacturing
  • Driving working capital synergies through post-merger integration programs

The effectiveness of working capital management processes can be attributed to the focus on cash, costs and capital discipline adopted by the industry in recent years.

What’s next for mining and metals companies?

For many years, the performance of the mining sector has lagged behind other sectors. Increasingly delivering shareholder returns and creating economic value for the future will remain at the core of investor expectations.

Summary

The return to growth brings opportunities for future outperformers to restructure their portfolios and create unique value for shareholders.

About this article

By

Lee Downham

EY Global Mining & Metals Transaction Advisory Leader

Advising on transactions for EY Mining and Metals clients since 2004. Focused on buy-side and sell-side due diligence and public market listings.