Trouble for mining’s middle of the pack

In the last 12 months Australia’s top 50 mid tier miners have plunged into the red, posting losses of more than $1 billion dollars, while there was no love lost with investors, wiping more than $17 billion off market values.

Advisory firm PwC has released its Aussie Mine report for 2013, titled Unloved… Survival of the Fittest, which doesn’t paint a pretty picture for Australia’s miners with about 33 per cent of market capitalisation lost over the 2012-13 financial year.

Analysing the largest 50 mining companies listed on the ASX with a market capitalisation of less than $5 billion at June 30, total market values came in at $35 billion, compared with a peak in March 2011 of $75.3 billion and $51.8 billion last year.

According to PwC’s seventh annual report the mid-tier's woes came despite operating revenues rising 2 per cent, production volumes for more than half the sector up more than 30 per cent and continued heavy investment into expansion.

PwC's Energy, Utilities and Mining leader Jock O'Callaghan said winning back investor confidence is going to be critical especially since much of the sector was still grappling with the challenge of bringing on line sufficient production to meet the world's demand growth projections.

“Without regaining investor confidence and failing to demonstrate its match-fitness to maximise shareholder returns in these leaner times, many in the sector face a period of uncertainty,” O'Callaghan said.

"We remain convinced that the omnipresent megatrends of global resource scarcity, urbanisation and the eastward shift in global economic power will drive long term prosperity for the mid-tier 50 sector.”

He warned that despite the big figures being bandied about, Australia’s mining sector is still going strong; it’s just coming off a bigger base.

"Let's keep this in perspective – we have a resources boom that has eased, not a bubble that has burst," O'Callaghan said.

Surviving and thriving through booms and busts requires the right combination of assets, access to funding and a strong focus on operating performance, O’Callaghan explained.

"Separately, any one of these factors can become a company maker but getting all three working together represents a trifecta for success,” he said.

Despite challenging market conditions, the report states opportunity still exists for the mid-tiers to capitalise but it warns only the fittest will survive.

 

Dealing with it money.jpg

Analysing the annual results of the biggest 50 miners with market capitalisations below $5 billion as of June 30 2013, the reports cut off for inclusion this year plummeted to $AU172 million for Bougainville Copper, compared to $463 million in 2011 and ranges through to $4.18 billion for Iluka.

Despite predictions in early 2013 that the industry would see a rise in merger and acquisition activity, the overall drop in market values failed to trigger consolidation with the number of completed and pending transactions falling to 14 from 22 the year before.

"The lack of M&A again reflects risk aversion among investors,” O’Callaghan said.

“Investors appear especially shy of any targets that have large and variable capital expenditure programs, lengthy project construction periods, are complex operationally and have high running costs. But those with strong balance sheets and, especially for iron ore and coal miners, those with greater access to infrastructure will remain attractive."

There also appears to be a lack of committed buyers in the pool, the mid-tiers are relatively cash poor and the majors are in the midst of implementing a raft of cost saving measures.

Transaction values also took a hit, falling 86 per cent to $2.6 billion.

PwC explains that when the two largest transactions (which were forced by the Zimbabwean Government) are taken out of the mix, deal value slips to $1.1 billion.

O’Callaghan said deal activity is weak.

"The underlying interest remains reasonably strong but the factors needed to get deals across are less than compelling," he said.

PwC suggests interest from Asian investors has also come off the boil with only four deals worth $4 billion being announced, one of which was the aborted $3.7 billion bid for Arrium.

However the company predicts this is only a short term trend, flagging interest to pick up in June 2014 once leadership in China’s state-owned enterprises settles down.

PwC said it is also seeing growing interest from Korean and Japanese trading houses considering Australian resources in a bid to secure supply for their downstream industries.

"With China bidders showing more restraint, conditions in the first half of 2014 may prove more tempting for Japanese and Korean companies to have a tilt at Australian resources,” O’Callaghan said.

Shareholders are driving change amongst miners, no longer are companies executing a growth for growth’s sake agenda where adding extra ounces or tonnes was the aim of the game.

Investors are now demanding capital discipline and calling for increased returns, PwC explains.

That said, many mid-tiers continued to invest heavily in projects throughout the 2013 financial year.

PwC said capital projects are a long-term decision.

“The companies who spent the most capex during the year, did so on projects which were approved and started before commodity prices started to come down,” the advisory firm stated.

“Mining is a long-term game and decisions to spend shareholder funds take years to play out.

“Once projects are started they are very difficult to slow down, as the incremental dollar spent to finish generates a higher return than the overall project.”

 

Key commodities Cook-Colliery.jpg

While production grew across key commodities, so did costs.

Across the 50 companies included in the report, costs increased seven per cent while margins dropped 40 per cent in 2012 to 34 per cent.

Volumes for half of the field grew by more than 30 per cent, representing years of investment coming to fruition through the ramping up of projects into a production phase.

In April 2013 gold ended its dream run, falling off its pedestal and awakening the bears with some predicting it could drop as low as $900 an ounce.

While that didn’t happen the decline did result in gold miners taking the axe to their workforces, with extensive job losses and a number of assets being offloaded.

However gold production still rose 24 per cent over the year, equating to an additional 577,000 ounces.

But of the mining sector’s $3.5 billion in total impairments, gold miners accounted for almost $2 billion.

Gold costs per unit jumped 17 per cent, reflecting poorer grades, high capital costs and new mines ramping up.

The coal sector took the brunt of the slowdown with gross margins falling to 13 per cent, PwC explains.

With coal prices falling throughout 2012-13, miners were left to deal with margin pressure, wiping $1 billion in revenues from coal producers which offset a 1 per cent drop in costs.

Yet coal production grew 27 per cent.

While the iron ore price stabilised recovering from its sharp drop in September 2012, PwC said there will be more downward price pressures to come with new supply coming online, outstripping demand.

To date, this has not manifested, Chinese demand is on the up and over the year iron ore production increased 45 per cent, but costs also jumped four per cent.
 

Value for money? up-or-down.jpg

An interesting finding emerging from the PwC report was that the net assets of the pool was below market capitalisation.

The mid-tier's $39 billion in net asset values exceeds its $35 billion market value despite a record $3.5 billion in asset write-downs.

"Only two conclusions can be drawn," O'Callaghan said.

"Either the market has oversold the mid-tier 50 or it remains over-valued. Again, the sector needs to make the case and convince the market it's been oversold."

Iron ore displayed the biggest deficiency with gold and coal not too far behind.

“A further $1 billion in impairment charges are expected from companies with December reports – indicating more pain to come,” PwC said.

But it wasn’t all dark and stormy; within the mid-tier 50 list were a number of success stories including Sirius Resources which have recorded a 5334 per cent market capitalisation increase following the discovery of a nickel sulphide system in Western Australia.

BC Iron, another success story, increased its net profit after tax by 243 per cent or $51 million in FY13 after pushing up output and increasing its interest in the Nullagine joint venture with iron ore major Fortescue Metals Group.

 

The productivity-profitability equation 

One of the biggest challenges for miners this financial year will be balancing productivity with profitability.

“The cyclical nature of the mining industry has illustrated how a pursuit of production volume can become unbalanced, to the detriment of productivity,” PwC explains.

During the most recent boom miners honed in on delivering volume quickly, a strategy which has resulted in inefficiencies which PwC says in many cases are now a structural pillar in many mining operations.

PwC says many of the mid-tiers are now seeking to maximise returns through optimisation and enhanced productivity.

“The real challenge lies in setting a path towards sustainably reduced costs and capital efficiencies and effectiveness,” PwC says.

In achieving this, PwC said technological innovations are going to be crucial.

“There are many technologies and innovations that reduce the effort required to extract resources across the entire supply chain,” PwC said.

“However before investment in technology is made, a detailed understanding of data and processes is critical to capital efficiencies.

“Technology alone cannot provide the solution if inefficiencies are not well understood.”

While technology is important, understanding what it does on at an operational level and having a dedicated, skilled workforce goes a long way when it comes to balancing the equation, PwC says.

“It’s the interpretation of the data that supports effective decision making,” the company stated.

“Culture plays an important role in implementing new processes and technologies – the workforce must be willing and able to support change in the transition phase to minimise the impact productivity.”

Mining service companies

Australia’s mining service and supply companies are being hit hard by the productivity and cost stick as miners tighten their belts.

The movement of miners lowering costs and reducing capital hasn’t run its course, with PwC’s report warning in its report that the worst is likely yet to come from mining service companies.

The advisory firm said only the “fittest and most agile” contractors will see the rationalisation period through.

As miners search for productivity improvements many mining service and equipment providers are being forced to adapt to both a lower margin and utilisation environment.

Throughout 2013 the profitability of mining service companies significantly declined, with the likes of WorleyParsons, Downer EDI, Leighton Holdings, Forge Group and NRW all reporting a tough year and some lowering profit guidance for 2014.

Looking into FY14, PwC said it expects pressure to continue on mining service providers to diversify right across the value chain, service offerings, commodities and geographically.

“As mining companies implement cost saving measures and look to further insource work, contractors will have increased capacity,” the advisory firm stated.

“This will increase competition between contractors and there will be a greater focus on services which are value-adding to achieve greater production efficiencies.”

To read the full report click here.

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