Satisfying investor demands, debt and working capital in mining and metals
The sector has to search for long-term strategies to drive competitive and sustainable shareholder returns. Depending on strengths, there are options to grow production volumes and optimally reconfigure assets within their portfolios.
We look at this is two sections:
Satisfying investor demands: we focus on what this means for the sector in terms of capital structure, growth prospects and the industry’s ability to satisfy the returns demanded by its investors.
Debt in mining: we analyze the debt levels in the sector and conclude that the industry had significantly brought leverage under control, driven by strong earnings momentum.
Satisfying investor demands
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. In essence:
- Capital structure for the sector continues to change; gearing dropped to 32% at the end of 1H17 for the top 50 miners, two 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.
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:
- 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.
- Portfolio optimization: the divergence of commodity markets and increased volatility demands mining companies to maintain a balanced portfolio which is able to cushion against unexpected adverse price movements.
- 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.
Miners tackle debt and leverage
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.
Did financing costs peak in 2016?
Financing costs increased significantly at the beginning of 2016 due to poor credit ratings and a negative outlook on the sector.
Consequently, miners in most regions of the world faced great difficulty in accessing conventional capital with China being an exception.
Interest expenses increased in 2016 despite falling proceeds, highlighting the rising cost of capital in the industry as lenders viewed the sector as high risk.
Opportunities still remain in 2017 for mining companies to retire unsecured instruments in favor of lower cost and more flexible facilities, supported by an improving credit outlook for the sector.
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.