Excellent capital stewardship, robust organic growth and a strong credible outlook for value creation helped the global mining industry average total shareholder returns (TSR) of 18% between 2001 and 2011, while the S&P 500 eked out an average 3% during the same period.
“Even more remarkable was the decade-long annual average TSR of the industry’s top ten: a stunning 39%,” says a new report by the Boston Consulting Group issued Monday. “Furthermore, unlike their industry peers, the top ten mining companies continued to earn high TSRs during the second half of the decade, the period encompassing the global financial crisis.”
The Boston Consulting Group (BCG) calculates TSR as a product of multiple factors including the combination of revenue growth and change in margins as an indicator of a company’s improvement in fundamental value.
It then uses the change in the company’s valuation multiple to determine the impact of investors’ expectations on TSR.
Finally, the model also tracks the distribution of free cash flow to investors and debt holdings in the form of dividends, share buy backs, or repayments of debt in order to determine the contribution of free-cash-flow payouts to a company’s TSR.
In the report, “Value Creation in Mining 2012, Taking the Long-Term View in Turbulent Times,” the Boston Consulting Group noted revenue increases attributable to rising commodity prices accounted for nearly 14 of the total 18% TSR that the industry averaged.
The remaining 4% came from a combination of production increases, margin expansion, and contributions from cash flow.
In their study, BCG also determined that “the mining industry clearly benefitted from the continued economic expansion in emerging markets, which led to steadily rising commodity prices. Value creation also was fueled by production growth, margin expansion, and cash returned to equity holders”.
The report also names the mining industry’s top ten value creators for the period of 2001-2011.
Ranked number one on the list is Mexican miner Industrias Peñoles, which generated an average TSR of 58.2%, followed by Grupo Mexico at 49.5%; the United Kingdom’s Randgold Resources at 45%; Canada’s First Quantum Minerals at 42.7%, and China’s Inner Mongolia Yitai Coal at 40.2% TSR.
Rounding out the top ten were sixth-ranked U.S. miner, Cliffs Natural Resources at 40.1% TSR; South Africa’s Exxaro Resources at 39.2%; Sociedad Químaca y Minera de Chile (SQM) at 36.9%; The United Kingdom’s Antofagasta at 32.4%; and China’s Yanzhou Coal Mining at 30.1% TSR.
“In every dimension—from profit growth to cash flow contributions to multiple expansion—the top ten mining companies outperformed the rest of the sample,” BCG observed.
“Even more impressive was the fact that commodity exposure had no impact on success; the top ten included a broad range of mineral producers, from gold and copper to coal and industrial-mineral companies.”
The study identifies three factors behind the dramatic performance of the top ten including the fact they managed their capital expenditures and consequent cash flows wisely. These companies also showed restraint in issuing equity, while also paying higher dividends than the report’s overall sample.
The top ten grew organically for the most part, while other companies in the sample expanded production through mergers and acquisitions.
“They built a strong, credible outlook for value creation, as reflected in their valuation multiples,” said the report. “By demonstrating a track record of success and a strong pipeline of opportunities, the top ten companies won over investors.”
Beyond the top ten, mining companies operating in rapidly developing economies generally experienced a similar effect, Boston Consulting Group observed.
The report urged mining companies to plan for a range of scenarios including the calamity that has befallen the U.S. coal industry.
“To get an idea of how rapidly market conditions can change, and the havoc that rapid change can unleash, one need only look at the coal mining industry in the United States. From a position of relative strength as recently as early 2011, the industry has suffered declining coal prices and falling demand.”
“Margins have been halved (or worse) since the beginning of 2011, projects have been delayed or cancelled, and several mines have closed,” the study noted. “The stock price of most U.S. coal companies dropped by 60 to 80% in the 18 months since early 2011, owing to failing profitability and multiples. One major company was forced for file for bankruptcy under Chapter 11.”
“The U.S. coal industry provides a cautionary example of just how quickly industry fortunes can change,” said Boston Consulting Group.
“Still opportunities to create value clearly exist: companies with healthier balance sheets can acquire good assets at reasonable prices (or even average mines cheaply, as effectively ‘out of the money’ call options).”
“In other words, companies that have exercised discipline in their value-creation strategies and execution can take advantage of turbulent times to seize opportunities—and build for the future,” said the report.
“There are lessons here for all mining companies,” said Gustavo Nieponice, a BCG partner.
“And they will only become more important as companies face persistent market uncertainties, increasingly challenging industry economics, and growing social and policy risks.”
The study highlights the challenges mining companies face, including: increasingly challenging economics from declining ore grades and higher strip ratios.
“Given the outlook for grades, investment in innovation will again become an important driver of competitive advantage for mining companies. In addition, the search for higher grades and better deposits has encouraged explorers and major players alike to seek out geologically promising, underexplored regions,” the report observed.
Social and policy risks—both in the developed and developing world—have been an escalating challenge for mining in recent years. “Uncertainty regarding government policy is widespread,” said the report. “As mining companies make more forays into new regions than they make into new minerals, it becomes all the more important that they have a clear strategy for dealing with resource nationalism and related policy risks.”
Boston Policy Group’s observations and analysis suggest four key levers which can help mining executives in their value generating efforts.
Lever 1: Revisit and Pressure-Test the Company’s Value Creation Strategies: Take the investor into account. Get capital allocation and portfolio management right. Maintain capital discipline. Manage through the cycle. Be prepared for interim shocks.
Lever 2: Manage County Risk and Stakeholder Relations: Recognize the importance of managing stakeholder relationships over the long term. Identify key stakeholders and the media landscape and know how mining in general is perceived by the population. Establishing thoughtful community-development effort should be a priority.
Lever 3: Up the Odds of Project Success: Project excellence is achieved through a disciplined approach to capital expenditures. It also calls for strengthening project governance, managing projects with an end-to-end view, and strategic management of project resources.
Lever 4: Develop an Advantaged Operating System: Get the fundamentals right. Make the most of existing assets. Optimize procurement, share best practices, and improve repeatability. Investigate next-generation mining techniques. Create people advantage by defining employee value proposition, adopt strategic workforce planning to ensure an adequate pipeline in key skill areas, manage talent on a continuing basement, and centralize talent and people management efforts—where it makes sense to do so.
The report’s authors include Nieponice, Thomas Vogt, Tom King, Christian Kӧpp, Victor Scheibehenne and Ross Middleton.
To download a copy of the report, “Value Creation in Mining 2012, Taking the Long-Term View in Turbulent Times”, go to www.bcgperspectives.com
This article appears courtesy of Mineweb. To read more global and financial mining news click here.