Miners are no easy meat for bankers

The sweet and the sour: a look at the changing role of debt in global mining.

JOHANNESBURG - 

When UC Rusal, advertising itself as the world's No 1 aluminium and alumina producer, listed last month in Hong Kong, its prospectus described a group with net debt of USD 13.4bn on 30 June 2009. This is a lot of debt. Earlier this month, Rusal announced, following the listing, that that it had repaid creditors USD 2.1bn, and that "as a result of the debt repayments Rusal's total outstanding debt including debt owing to Onexim was reduced to USD 12.9bn". This is still a lot of debt.

Rusal ranks as one of the world's most indebted mining groups. The timing of Rusal's listing was inopportune, given the relatively poor performance of aluminium right across the so-called commodities supercycle, from early 2002 to around mid-2008. China's ability to source alumina-carrying ores, twinned with the ability to commission new and relatively inexpensive power stations on time, has fundamentally altered the dynamics of the global aluminum sector.

Alcoa, which ranked as the world's biggest mining company, by value, just five years ago, is now rated No 36. While the quality of its management and its business model remains fully blue chip, its status as a blue chip investment sits on a knife edge. Within the past year, Alcoa's stock price has fallen to below USD 5.00 a share, to levels not seen in more than a decade. It has recovered to over USD 13.00 a share, but the point has been made.

Alcoa's net debt fell from nearly USD 10bn at the end of 2008 to USD 8.2bn at the end of 2009, assisted by a rights issue that raised USD 876m. So sure was Alcoa of its future that in the previous two years alone, it splashed out USD 2.5bn on stock buybacks. Rio Tinto, which falls in the top five miners in terms of ownership of diversified Tier I global mining assets, was so sure about the future of aluminium that it literally hurled USD 38bn in cash in 2007 at buying Alcan. The enlarged Rio Tinto aluminium division lost more than USD 600m during 2009.

Anything more about aluminum would probably throw the average investor into a fit, and anything about the bloodbath in nickel would be too much, even for those dosed up on a liter of ether.

The commodities and metals that stepped into the breach, so to speak, were, above all else, seaborne iron ore, seaborne coking coal, and copper. It is for good reason that the world's top three miners, by value, rate as BHP Billiton, Vale, and Rio Tinto. The trio collectively hold about three-quarters of the global seaborne iron ore market, and substantial positions in seaborne coal (coking and steam), where Vale is quickly building up capacity. The three also collectively hold a strong position in global copper.

The operating cash flows of the three leading global miners, aggregated with seven others, shows that over the past three calendar years, the grouping generated USD 195bn in operating cash flows, of which USD 115bn was routed into capital expenditure. Operating cash flow fell heavily from USD 83bn in 2008 to USD 48bn in 2009. Net debt for the grouping fell from USD 102bn at the end of 2008 to USD 83bn at the end of 2009. There were some significant rights issues during the year, led by Rio Tinto, which raised USD 15bn.

For these big, and generally strong, miners, debt was easily serviced during even the darkest days of 2009. Banks, more terrified of each other than anything else, bunkered down into deep dungeons to figure out how the next set of bonuses could be cranked out of the system. Politicians panicked after bank lending all but froze after Lehman Bros. croaked on Wall Street on 15 September 2008.

Even class-leader miners had to look elsewhere. De Beers, the dominant name in rough diamond mining, received substantial interest-free shareholder loans, and recently announced a USD 1bn rights issue, mainly a debt-for-equity swap, with its three shareholders. Anglo Platinum, No 1 in platinum-group-metals, received substantial loans from 80% parent Anglo American, and recently announced a USD 1.6bn rights issue, also mainly a debt-for-equity swap, to clean up a damaged balance sheet.

The corporate bond market was as quiet as a graveyard during 2009; only the strongest mining names popped up. While bonds, and also convertibles, are classified as debt, the buying pool is essentially the same as the one that buys equities. Coupons ranged from a low of 4.75% for BHP Billiton's euro bonds, to 9.375% for Anglo American's dollar paper. Teck, a smaller company that inherited substantial debt after the takeover of coking coal major Fording, issued notes with coupons of more than 10%. 

In the overall mix, net debt held by mining companies fell during 2009, and has fallen more this year. While bankers worked tirelessly on the next best way to rescue the world, and the universe, it was equity investors that supported the global mining sector significantly during a depressing and unpleasant time. Where banks did make an appearance, mining companies were kicked straight in the nether regions.

On its knees, Johannesburg-listed Metorex announced an equity and debt issue in November 2008, where a domestic bank extracted an "interest expense" based on "an annual interest rate of JIBAR plus 7.5% (nominal annual compounded monthly) with JIBAR being assumed as 11% per annum". Add that to the 5% commitment fee, for a cost of around 20%, and consider a rate that would be seen as extortion in many parts of the world.

Banks saw troubled miners as easy meat. Banks have no reason to believe that mining companies deserve special attention, but then Goldman Sachs, Wall Street's blue blood outfit, described at least once as a giant vampire squid, apparently believes that nothing except its own objectives need any special attention at all. Like any economic enterprise, miners will need banks, from time to time, just as miners, the people, have no choice but to offer nature's call.

One of the takeaways is that mining companies could look at cash preservation over longer cycles than the perversely tiny cycles that day-traders obsess over. Whether equity investors would accept this notion is another issue; there is a tired and inept adage that companies should resist "lazy balance sheets", and return excess cash to investors as soon as is practical.

Consider Anglo American, which returned USD 16.4bn in cash to shareholders across the three calendar years 2006 to 2008, USD 10.4bn by way of stock buybacks, the balance by paying cash dividends. Even today, however, a good number of investors experience fits of depression when reminded that during 2007 and 2008, Anglo American spent USD 6.7bn on iron ore assets in Brazil, including 100% of Minas Rio, and 49% of LLX Minas Rio (port of Açu).

There is no question that the sellers received a premium, but critics seem to have completely forgotten that USD 16.4bn of cash was returned to investors over three years. Anglo American has resisted rights issues; so far as anyone seems to know, it has not used such a device since its founding in 1917. Today, it ranks as one of the world's most indebted mining companies. During the next upcycle investors may consider backing off if Anglo American accumulates cash; they will also need to deal with the more palatable idea of bankers paying interest on the deposits.

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