Stop. Think…Act - PwC Mine 2017 report

According to PwC’s Mine 2017 report, the world’s Top 40 miners recovered from a race to the bottom, with bolstered balance sheets and a return to profitability in 2016, giving them much-needed space to pause and draw breath. 

As it looks to the future, the 14^th edition of PwC’s industry series analysing financial performance and global trends, also outlines the new opportunities and hazards on the horizon.

Jock O’Callaghan, Global Mining and Metals leader at PwC, commented:

“We see the 2016 narrative of the Top 40 reading more like a mine site safety mantra: ‘Stop. Think… Act’. The industry has moved out of danger but 2016 was not a year of action, and we now wait to see who will be bold and step out beyond the fluctuating market confidence.”

The report recognises a return to profitability in 2016, with an aggregate Top-40 net profit of $20 billion; after an aggregate loss of $28 billion in 2015. The improved fortunes of the industry were then directed to strengthening balance sheets.

Capex fell dramatically again, by a further 41 per cent, to a new record low of just $50 billion.

Debt repayments totalled $93 billion, up from $73 billion a year earlier, with most of the debt issued used to refinance, rather than fund acquisitions or mine development.

Jock O’Callaghan added:

“We see an improved gearing ratio of 41 per cent, down from the 2015 record of 49 per cent. But this is still well above the 10 year average of 29 per cent. Interestingly, we also found that around half the capex figure was invested in sustaining activities, so the growth capital portion was strikingly small compared with previous years.”

Sacha Winzenried, PwC Indonesia's lead advisor for energy, utilities and mining, commented:

“The global data is consistent with our experience in Indonesia; mining exploration capex has been slashed in recent years; the coal industry in particular is concerned that there’s not enough capex to sustain production at current levels and to expand in the future to meet increasing domestic demand for coal”

In Indonesia,  the banking sector’s non-performing loan levels with mining companies have finally stabilized in 2017, and banks are reportedly  again willing to lend for mining projects.

Rapidly rising commodity prices sparked renewed market optimism and improved credit ratings across the Top 40 firms and the industry at large. Thermal and coking coal saw huge price swings in 2016, largely due to China’s announcement that it would reduce the number of coal mining days for the year, although this policy change was later reversed. Iron ore also jumped on the back of Chinese manufacturing and steel expansion, but all metals ended the year higher than they began.

Sacha Winzenried added:

“Global drivers such as Chinese demand still dominate spot prices, but margins in Indonesia are significantly impacted by local regulations as well as fuel and contractor costs. Based on 2017 Power Purchase Agreements signed, we also see significant upside for local demand for thermal coal coming from the 35 GW programme, although perhaps less quickly than industry hoped for. Miners will have to pay close attention to fuel costs though, which are rising quickly”.

Valuations also climbed, especially for miners from traditional markets, with the trend continuing through Q1 2017 even as commodity prices remained flat. In Indonesia, the market cap of IDX-listed mining companies increased by around 95% during 2016.

But, valuations aside, there is little to suggest that the Top 40 miners made any substantial advances throughout the year. For the fourth straight year, the industry reduced spending on exploration. $7.2 billion was invested¹ in 2016, barely one-third of the record $21.5 billion allocated in 2012, with the funds cautiously targeted at less risky, later stage assets, typically located in politically-stable countries.

Limited M&A activity

One of the biggest M&A stories of 2016 concerned the assets that did not sell. Numerous large deals, expected to be completed by early 2017, were withdrawn from the market, possibly due to the rebound in commodity prices and the improving prospects of the companies that owned them.  More broadly, asset sales in 2016 were largely strategic rather than fire sales. Miners, especially diversified players, sold minority stakes in non-mining businesses.

Sacha Winzenried commented:

“The M&A story in Indonesia in 2016 was the notable transfer of ownership from foreign to local players. We witnessed the sale of BHP Billiton’s remaining interest in huge undeveloped coking coal deposits in Central Kalimantan to their partner, Adaro, and the exit of Newmont from Indonesia, selling its copper and gold assets to a local consortium”

China in the driving seat

China remains the exception to the dominant investment behaviour within the Top 40.  During the downturn, Chinese companies demonstrated one enormous advantage over other miners from both traditional and emerging countries: access to capital.

With deeper pockets, Chinese players were able to fund more acquisitions than their counterparts, either confidently buying assets at bullish prices or moving quickly on assets made available at the bottom of the price cycle. We also witnessed an increase in acquisitions by Chinese private equity firms, and we expect China to continue to be active in acquiring global mining assets as a way to reduce its longer term dependency on imports. In Indonesia, Chinese firms were prominent investors in smelters to meet local regulations requiring value-add to metal ores before export.

Moving into Action

Balance sheet clean-ups require discipline, and this has resulted in a tailing-off of impairments, the avoidance of any new bankruptcies, the absence of any new significant royalty streaming transactions and a general passing of financial distress. The market rightly applauded this, reinstating a positive spread between market caps and net book values that was absent in 2015.

All of this provides a platform for decisive action in the future. While many will be willing to ride the waves of industry sentiment, others will see the conditions as ripe for value accretive moves, with market differentiation their immediate goal.

Action might also come in the form of commitments to greenfield projects, M&A or technology – or a combination of these – while others may realign their strategy in response to external forces such as recycling and substitution, shareholder activism and government intervention.

The Government of Indonesia appears committed to a more sustainable expansion than the 2008-13 boom, making efforts to enforce the “Clean and Clear” list. However, the status of key producers operating under lex specialis arrangements such as Contracts of Work, will need to be clarified for Indonesia to remain attractive for increased long-term investment.