Miners have recovered from the latest downturn after spending years reshaping their portfolios, paying off huge debt piles and shoring up their balance sheets. But with firms like Rio Tinto, BHP Billiton, Glencore and Anglo American generating cash again, questions are being asked of how best to spend it.
Miners: shareholder returns trump investment
Miners are back on the front foot but big questions remain, particularly about how to spend the growing piles of cash in the bank. The Top 40’s free cashflow was up over 77% in 2017 and at its highest level for six years and billions more has come from huge asset sales but, with debt now at manageable levels (gearing has dropped down to levels not seen for ten years at about 31%), the industry is facing a dilemma of how best to spend it.
Right now, investors are being sprayed with cash while investment has remained largely stagnate. The value of dividends and buybacks more than doubled year-on-year in 2017 while capital expenditure was at its lowest level for a decade at $48 billion (only $5 billion more than what was returned to shareholders), and while there is concern that the lack of investment will eventually catch up the industry is learning from its mistakes.
While the ups and downs are to be expected, the latest downturn was particularly hard-hitting for those that were too willing to buy or invest in new projects when prices were high as they prioritised production at any cost, leaving them vulnerable when the downturn came around.
This is what prompted the industry to aggressively drive down costs and forced many to sell-off swathes of assets to address their bloated portfolios and cut out any cash-draining elements. While it is always staggeringly impressive how much the natural resource sector can save when push comes to shove, it is also equally astounding at how wasteful the industry is when times are good.
This is why, for now at least, miners have been leaving tidy sums in the bank, investing less and returning more to shareholders, in fear of spending too much and repeating the same mistakes. The sector’s over-investment when prices were high accelerated the path toward over-supply, explaining why they have not been as key to start spending as quickly as they have done before.
Plus, the overall appetite to buy new assets is low considering most have just spent the last three to four years streamlining their own portfolios and offloading assets, returning most of the proceeds to investors rather than reinvesting it. Any company sitting on a huge pile of cash comes under pressure to spend it one way or another as leaving it idle offers little benefit, and having seen their dividends cut or even suspended over recent years investors will be applying the pressure to recoup what they would argue is owed to them following years of patience.
Mining industry focuses on optimisation and efficiency
According to PwC, the top 40 mining companies sold off over $6 billion worth of assets last year, more than analysts had predicted. Many have downsized their metal mix and started to concentrate on a select few that offer the best long-term fundamentals.
More concentrated portfolios means the biggest miners have started to take different paths, implying they also have some differences as to where the long-term potential lies. Rio Tinto’s radical overhaul included a complete exit from coal (mostly thermal for electricity generation), making it the only one of London’s ‘Big Four’ to hold no exposure to the commodity. Glencore was among the purchasers of Rio’s thermal coal assets in Australia, and coal is also a large earnings-drivers for competitors Anglo American and BHP Billiton. Another substantial shake-up took place at BHP, which, having stood out from its peers by holding a large US shale position as well as its mining operations, sold off its petroleum interests to BP to focus on metals.
The sector’s restructuring has also seen miners increase their stakes in any joint ventures featuring in areas which they are doubling-down on. Glencore bought out the Mutanda and Katanga operations in the Democratic Republic of Congo, the latter of which has the potential to become ‘Africa's largest copper producer and the world's largest cobalt producer’. Copper has long been a core metal for the business but the heightened focus on the likes of cobalt is a reflection of increasing appetite for metals not previously prominent within their portfolios and driven by new trends such as electric vehicles, which has spurred demand for other metals including lithium.
With balance sheets now steady, the rate of asset sales has slowed and some have called for an end to their restructuring, with recent proceeds mostly being returned to shareholders. Both Rio and BHP are returning the sums from their exits to investors, supporting the view that miners are currently concentrating on maximising shareholder returns over splashing out on acquisitions or making any big investments. The vast majority of miners were forced to cut their dividend during the downturn or even suspend payouts altogether, but most have now reintroduced their dividend policies. Rather than raising dividends more than is necessary (placing pressure for higher future payments), miners are returning cash by buying back their own shares. Share buybacks are more flexible and also allow the miners to take advantage of what they perceive as an undervalued share price amid rapidly improving cashflow generation.
Rio Tinto delivers record returns for investors
Rio Tinto has led the surge in shareholder returns from the sector, having committed to returning over $7 billion at its interim results for the first half of 2018. That includes $3.2 billion of proceeds from selling its coal assets and $1 billion of cashflow being returned through buybacks, and a record interim dividend worth $2.2 billion ($1.27 per share vs $1.10).
This year’s returns build on the $10 billion it returned to investors last year, which is reported to have accounted for half of all the returns made by the sector. This has been possible because Rio did not share as large a debt burden as its peers, allowing it to continue returning sector-leading sums to shareholders while rivals paid their bank managers. Still, Rio has reduced debt over recent years.
Since Jean-Sebastien Jacques took over at the helm of Rio Tinto in 2013 the company has been known for its focus on improving the performance of existing assets and squeezing out as much cash as possible to return to investors. Between 2017 and 2021, Rio plans to sweat an additional $5 billion worth of cashflow from productivity improvements, with $400 million to be delivered in the second half of 2018. Meanwhile, capex is set to remain broadly flat this year at $5.5 billion and only tick up by about $500 million per year over the following years.
Over the last five-and-a-half-years Rio has cut debt from a $19.3 billion while returning over $35 billion to shareholders, and more substantial sums could be on their way too with Rio having struck a $3.5 billion deal in July to sell the Grasberg copper project in Indonesia that should close before 2018 draws to a close.
Rio Tinto is now focused on just four commodities, with iron ore at the heart and the biggest driver of both revenue and earnings. The money that it is investing is currently being funnelled into its automated rail network at its vast iron ore operations in the Pilbara region of Australia, building capacity and demonstrating the benefits technology can yield for the sector. In terms of actual mines, building an underground mine at its existing Oyu Tolgoi copper mine in Mongolia is the main focus, although the $5.3 billion project is still years from production.
Glencore: share buybacks are the best use of cash
Glencore has also focused on using buybacks to return cash to shareholders, with chief executive Ivan Glasberg stating he and the board ‘don’t see any deals that look really exciting’ when it released its interim results in August, adding ‘we believe buybacks are the best returns we can get for the company’.
Glencore is unique compared to its peers. While it does mine like the others it is known for being the biggest commodity trader in the world, shifting not only its own but everyone else’s natural resources around the world. Its trading arm (Glencore refers to it as its marketing division) offers wafer-thin margins and volumes are therefore all-important, which is evident when you look at Glencore’s results:
This volume-based approach has pushed Glencore into higher-risks regions that others deem too dicey, and it’s seen the firm become known for testing the limits by working around international sanctions. While others have downsized, Glencore’s model demands diversity and it still deals in over 90 commodities in over 50 countries, including troubled states like the DRC.
Its mining arm, however, is more streamlined and the company’s main area from growth is the electric vehicle market, particularly copper and cobalt demonstrated by its buy-out of Katanga and Mutanda.
The overhanging issue at Glencore and one that is to cast a shadow over the business for the medium-term is the US Department of Justice’s investigation into claims of money-laundering and other fraudulent crimes related to business in the DRC, Nigeria and Venezuela over the past decade. This is one reason that Glencore’s appetite to strike deals has waned as investors begin to ask if Glencore’s model is simply too risky, and the choice of using share buybacks is made more appealing by the fall in share price sparked by the announcement of the investigation in early July.
You can read a more in-depth evaluation of Glencore here
Anglo American: a longer road to recovery
Anglo American was one of the worst affected by the downturn and had to suspend its dividend in 2016 following hefty losses and a need to address a debt pile so large that some were questioning its ability to carry on.
The company also went through a period of confusion as its recovery, including the reinstatement of the dividend last year, was only possible because of two commodities that it had vowed to exit: iron ore and coking coal. That understandably raised questions about its plans to focus on just three commodities – copper, diamonds and platinum – and has forced the company to step off its withdrawal plans and capitalise on growing demand for the likes of higher quality coking coal in China.
Anglo American didn’t follow the rest of the industry in the last downturn and continued to spend on exploration to find new deposits and while that exacerbated its financial woes it may have started to deliver results following reports of a potentially huge copper discovery at a project on the edge of the Amazon rainforest in Brazil. Anglo American’s chief executive Mark Cufitani has played down excitement and said firmer information will become available later this year. Copper has been at the forefront of its investment plans of late, having signed off on a $5 billion project in Peru in partnership with Mitsubishi.
Investors are also cautiously watching out for the possibility of Anil Agarwal’s Vedanta Resources making some sort of approach for the company following reports it was interested in launching a takeover. However, the reports were from unnamed sources and not verified by Vedanta, which recently announced plans to delist from the London Stock Exchange. Agarwal holds a 20% stake in Anglo American and his ability to launch a takeover bid is questionable, but it is definitely something worth considering going forward.
Net debt has come down and dividends have started to grow (up 2% in the first half of 2018 to 49 cents), but the returns on offer from Anglo American are far below that on offer from its London-listed peers. Pipeline leaks at its Minas-Rio iron ore operation are also set to knock underlying Ebitda by $300 to $400 million in 2018, dampening optimism over its annual results this year.
BHP Billiton: downsizing as trouble continues to brew
BHP Billiton’s $10.8 billion sale of its onshore US shale assets to BP had long been in the pipeline following calls from activist investors over the past two years and, once completed later this year, will see the company concentrate on just 13 projects and four commodities: iron ore, coking coal, copper and offshore oil. Back in 2013, when chief executive Andrew Mackenzie took over at the helm, BHP had over 40 projects.
Over $12 billion worth of productivity gains have been delivered over the last five years and it has reported particularly impressive cashflow over the last two, allowing a significant reduction in debt. And the buyback funded from the shale sale has sweetened the lift in its annual dividend for the year to the end of June to $1.18 cents from just $0.83 cents the year before, with the 42% lift above what its dividend policy demands.
BHP’s latest annual results were the best on record since 2014 and driven by its focus on maximising cashflow it expects to deliver $1 billion worth of productivity gains in 2019 with ‘strong momentum’ going into 2020 and beyond, and capex has been capped for at least the next two years at $8 billion per annum.
However, there is reason to be cautious going forward. Firstly, some analysts have forecast rising costs and flat production this year which could bring a halt to the growth it has delivered over the past two years, and it is still far from drawing a line under the fatal Samarco dam failure in Brazil in late 2015. The iron ore operation remains closed and BHP, which owns 50% of the project alongside Brazilian firm Vale, booked $650 million worth of costs related to the incident in the recently ended financial year and is facing multiple legal claims stretching into billions which are unlikely to be settled for some time.
The other overhanging issue for BHP which, having bowed to pressure from activist investors led by Elliot Advisers over its US shale position, is the next sweeping change that some shareholders will continue to push for. Elliot Advisers has been calling for BHP to separate its complex dual share structure for years, publishing a report earlier this year claiming $22 billion of value could be delivered by unifying its dual-listed shares in the UK and Australia and simplifying its corporate structure. This structure means BHP is made up of two separate companies with stock listings that work as if they were one enterprise.
BHP has always questioned the benefits of changing its share structure and the amount of value that Elliot believes could be created through change, stating earlier this year that its stance is that ‘the costs and risks of collapsing the dual listed class structure outweigh the potential benefits’. Those risks include being demoted from the FTSE 100.
What is the outlook for the mining industry in 2018?
Revenue, profit and cashflow are all forecast to rise further for the top 40 miners in 2018, and margins will also continue to improve. According to PwC, the results for the world’s top 40 listed mining companies in 2018 will be:
Net operating cashflow
Adjusted Ebitda margin
Return on capital employed
(Source: PwC, Mining 2018)
One barrier to seeing a significant rise in investment is the industry’s average margin which, although improving, is ‘still too low to incentivise significant new developments’, according to PwC, which believes higher Ebitda margins are needed to encourage the capital-intensive mining industry to invest.
With that in mind, London’s Big Four are well ahead of the rest of the sector when it comes to margins. In the first half, Rio Tinto reported a margin of 43% while Anglo American and Glencore’s mining operations delivered closer to 30% (Glencore’s overall margin was only 14%, taking into account the 4.6% delivered from its trading arm), while BHP’s recent annual results delivered the best margin of all at 55%.
Miners: balancing stakeholder demands and their long-term strategy
Miners have reshaped themselves and are now in a much more advantageous position, working toward a brighter outlook underpinned by forecasts for global economic GDP growth to remain steady over the next five years to provide support to commodity prices. However, geopolitical tensions are moving up the list of risks, with BHP one of the latest to warn that growing protectionism would hurt economic growth in 2019 and 2020 and not do any favours for the Chinese economy, which has already seen growth slow considerably ever since 2012. BHP’s vice president for market analysis and economics said last month that while there was currently no risk of a global recession, the rise in trade protectionism is ‘an exceedingly unhelpful starting point for the pursuit of broad-based growth across regions, expenditure drivers and industries’.
Having restructured their portfolios, lowered their debt and rebuilt cashflow most miners have started to implement their long-term strategies but are yet to put their foot down on the pedal and significantly up investment. The industry will find itself resisting the temptation to buy new resources and invest in new projects over the coming years and will remain disciplined for the immediate future. In the meantime, cash is likely to continue being dished out to shareholders and used to shore up balance sheets to ensure they have the financial firepower they need when investment and mergers and acquisition (M&A) starts to pick up once again. It is important to note that shareholders will not only be demanding higher returns as cash builds – governments are likely to seek higher taxes and staff higher wages. Quite simply, the pressure will remain on how miners spend their cash over the foreseeable future and they will need to strike a balance between meeting shareholder demands and implementing their long-term strategy, and they will be aware that holding back from material levels of investment will eventually catch up with them.