Death of the super-cycle leaves miners flatlining

Source: CBC

According to Venmyn Deloitte managing director, Andy Clay, this comes despite the fact that in rand terms, some commodity prices are their highest ever, but so are costs. “These mining companies will only successfully come out of business rescue in an environment of trust from financial institutions to go through the business rescue process.”

Dramatic action required

He says dramatic actions for survival are required by miners: an immediate cut back on current production; trim back to high-grade ore, where feasible; fix contracts that are no longer viable, if possible, or put the mine into business rescue; and stop all future plans and capital expenditure to increase production.
This is, he says, a life and death crisis for many mines and in South Africa there are a number of additional obstacles around policy uncertainty and lack of investor confidence.

Little prospect of recovery

“Many miners are flatlining with little prospect of recovery. The problem for most mining groups is that nobody foresaw the end of the commodities super-cycle, during which they complacently allowed company costs to get out of control.

Now that we have experienced a dramatic drop in commodity prices caused by over-production as the world invested too much in commodity infrastructure when prices were high.

Demand was driven by China, and today there is uncertainty as to that country’s economy. A lack of demand has caused raw material prices to fall, hitting commodity-dependent economies hard as it makes the extraction and export of such materials unviable. They are now trying to cut costs wherever possible – but this is difficult in an environment when revenue is falling with nobody able to predict when a recovery in prices will occur.”

Even the major producers are in trouble. Shares in world number one BHP Billiton - which relies heavily on oil and iron ore, the worst performing commodities over the 12 months - has been cut in half over the last year.

That's two-thirds below its highest market value in 2011 when it briefly became the fifth most valuable publicly traded company in the world, ahead of giants like Microsoft.

Rio Tinto, the world's second largest miner - based on revenue which relies on copper and iron for nearly 80% of its earnings - is down 59% from its record market value at the height of the commodity price boom. Anglos now trade 80.5% below its 2011 high.

Banks have become jittery

The solution sought by many companies has been to try lower average overheads by increasing economies of scale through mergers and acquisitions (M&A) – but Clay says this has simply worsened the problem of over-supply on the market and prompted a further spiralling down of commodity prices.

“During the boom times, all stakeholders from unions to shareholders demanded a bigger share of profit. At the same time, because of the low interest rate environment mining companies opted to fund themselves with bank debt even though the industry best practice has been to not do so but rather to fund new production with long-term shareholder capital. The result is that banks have become jittery and are calling in their loans,” says Clay.

One of the banks’ concerns is that accounting standard IAS13 (Fair Value) requires full ownership of an asset before it can be put on balance sheet, whereas most assets are on land where communities have made claims.

Therefore, mining companies do not have adequate security for these debts, and some are now treading close to insolvency. Banks do not want to lend under these circumstances, and shareholders are reluctant to put in finance in the absence of bankers’ due diligence.

Uncertainty on policy

“There is also considerable uncertainty regarding policy, particularly the Mineral and Petroleum Resources Development Amendment Act, and the ‘once empowered always empowered’ concept, burdens which are simply adding to what is already a dire situation for mines,” says Clay.

He anticipates heightened M&A activity emerging from the business rescue process, with cheap assets to be acquired in what has been a typical boom to bust scenario. The commodity super-cycle endured so long that many boards of directors are composed of people with no experience of a down cycle. This permitted mining companies to follow the fad of using debt instead of equity, debt that is now being recalled.

“Many companies are now in a debt trap. To revive the industry requires a return to basics and fiscal discipline,” says Clay.