MINING FINANCE / INVESTMENT
In a time of crisis, E&Y says mining companies can find significant opportunity
After surviving tremendous price volatility in the past year, mining companies must find the balance between caution and opportunity, a new Ernst & Young report advises.
Posted: Thursday , 10 Dec 2009
RENO, NV -
While the global financial crisis had left miners wary and loathe to make major decisions, a recent Ernst & Young study suggests companies prepared to make tough decisions and be the first to act, could discover "there could be significant benefit and opportunity right now."
"The mining and metals landscape has changed faster and more dramatically than anyone thought possible, and market unpredictability is quickly becoming the biggest challenge mining and metals companies face," said Tom Whelan, leader of Ernst & Young's Canadian mining and metals practice. "As a result companies need to be increasingly nimble when it comes to capital."
In the report, Lessons from change, Restoring growth in the mining and metals industry, E&Y finds mining's general priorities "have morphed from boom-related production constraints to back-to-basic efficiency gains, made in part through better capital and cash flow management, and heightened risk awareness."
The top mining companies are more strategic in their thinking on acquisitions, E&Y suggested. "Today, they are making considered decisions on what they will buy and when. They look for a strategic acquisition when the time is right, not resource replacement at any price."
SECURING MINING'S PRESENT
"Companies are no longer making big deals and bringing on new production without careful consideration," the report observed. "The result is that many are waiting for a competitor to make the first move-to bring production back on, or make transactions to expand capacity."
"All of them are waiting for a signal that the market is safe again."
Mike Ellliot, E&Y's global mining and metals leaders for Australia, suggested, "Survival remains the sole focus for many smaller miners and junior explorers as well as operators that made acquisitions financed by debt during the bull market phase. These companies were left swimming against a tide of debt repayment schedules, while simultaneously weighed down by falling metal prices."
Meanwhile, the study noted, "With access to capital limited and investor confidence down, these companies' prospects are increasingly uncertain."
Balance sheet repair is now the most pressing issue for many mining and exploration companies, E&Y advised. "Funding shortfalls have become an acute issue for the resources sector," the study found.
"Investors are by and large not interested in funding a period of low of negative margins," E&Y advised. Funding of new projects or refinancing of maturing arrangements "can be challenging as banks are loath to extend funding no matter how good the project."
Nevertheless, the study observed, "New and innovative sources of capital have emerged from Asian strategic investors, from sovereign wealth funds, private equity and Islamic funds, as well as Middle Eastern and Asian banks."
Sellers should be increasingly flexible in the deal structures they pursue and be open to alternative financing, the study suggested.
"Another risk-sharing and funding opportunity, beyond debt or equity is the joint venture. In certain situations, a joint venture can be an excellent way of creating synergies with other companies or new classes of investors, and can also be a good way to cut costs by increasing economies of scale for the project or the service."
E&Y advised smaller mining companies to consider optimizing security deposits on exploration licenses through focusing on those assets with the greatest value and deferring expenditure on others. In the meantime, mining and metals companies should consider whether to use contract mining, whether the sale or leaseback is being made at full market value and if the leaseback could detrimentally affect the level of control over the asset. "Managed correctly, capital tied up in surplus assets can be liquidated and thereby improve the return on investment."
However, those companies who have been canceling, deferring or reducing their capital programs to avoid surplus capacity could find themselves facing other risks, such as damaging its relationship with stakeholders. Cancelling or deferring investment in high risk or politically unstable countries "can damage sensitive relationships, lead to potential litigation, a loss of tax concessions and ultimately the loss of a license to operate," E&Y asserted.
"Public perception of corporate responsibility can be damaged as a result of mine closure or changes to capital programs. These risks are especially acute where towns exist almost solely to support mining activities and, therefore, heavily affected by changes to mining programs. This can further undermine corporate reputation in the local communities, with an effect on local and regional government."
The study found miners have focused on cost savings through three main approaches: reduction in cash operating costs, deferral of capital expenditure and active capital management.
Contracts with suppliers are being reviewed in the light of the new environment with more than half the miners negotiating longer-term contracts with suppliers.
However, the lack of capital investment, combined with cutbacks to exploration and development can threaten the future supply for companies, and conversely, "provide companies that continue to invest through the downturn with a golden opportunity once the market turns," E&Y advised.
A major stumbling block to this strategy is "many companies mistakenly believe that they will be able to undertake capital investment at short notice and rapidly accelerate the time to market. Not only is this a problematic idea, but when many companies are making a similar wager, simultaneous acceleration is not possible."
The study found mining and metals companies that had started to diversify in the recent boom are now focusing on their core business. Fewer miners are trying to reshape their company to deliver robust outcomes no matter how volatile the market.
High-cost operations and noncore assets have been placed in care and maintenance or sold.
SMART MINING AND METALS COMPANIES WILL...
•· Reduce debt and design capital structure flexibility
•· Create sustainable cost reduction
•· Create sustained access to capital
•· Divest while buyers are active
•· Manage their cash and working capital at all parts of the cycle
•· Add value through diversification
•· Stress-test risk management
•· Increase company flexibility to reduce pressures on stakeholders
•· Build in flexibility of core and maintenance
•· Retain hard-to-hire skills
To access an online copy of the report, visit http://www.ey.com/Publication/vwLUAssets/LFC-mining_and_metals/$FILE/LFC_mining_and_metals.pdf