World Mining Overview. (Features).
Looking back over the past year, the mining industry continued its decline as represented by several key statistics, such as the level of exploration expenditure and level of equity raisings. This masks some changes in the industry that potentially bode well for the future, such as consolidation of production and coordinated public relations.
Key points addressed in this article will include the fall in the level of exploration expenditure and its implications, including the obvious reduction in the number of quality new discoveries. The level of exploration spending, particularly by junior companies, is related to the availability of capital. In the past few years, there has been a substantial reduction in capital available to the sector as investors chase speculative returns in the "new" economy. The reduction in exploration and capital expenditures are contributing factors to the consolidation of ownership of production within certain commodity sectors, with existing producers pursuing growth through acquisition rather than development.
The capital markets are also less forgiving of past performance and the mining industry has a reputation for providing poor returns. The question these days for institutional investors is not, "what mining company to buy," but, "should I be in the industry at all." In answering this question, the main concern is whether the industry utilizes capital efficiently. Accordingly, the industry is now being evaluated more from a cashflow and earnings basis than a quantity of production basis. In turn, this is causing mining companies to focus on parameters such as return on equity and invested capital. The aggregate size of the industry is also an issue and will be put into perspective.
Consolidation is also driven by the recognition from senior companies that they need to exert greater influence on the pricing of commodities. Consumers are only too happy to have yet another source of supply leading to surplus capacity in a particular commodity. Producers are now understanding that greater restraint regarding new development is important for maintaining reasonable commodity prices, which feeds through to the appropriate return on investment calculation. Witness the concentration of ownership in aluminum, iron, diamonds, mineral sands, and copper in the past few years. Consolidation is also driven by the industry recognizing value while the broader investment community is distracted.
The industry is recognizing the need to win the hearts and minds of the broader community. We are seeing several initiatives, including the Global Mining Initiative, attempting to come to terms with the public's perception of the industry. It is essential that this continues.
The industry is still relevant and growing, but on a whole, needs to maintain financial discipline in order to attract capital within a very competitive financial marketplace. If there is light at the end of a tunnel, it is that there is increasing tension between the lack of new project generation and the increasing demand for most commodities, which will need to be addressed in some form.
The reader can appreciate that the mining industry faces other significant issues like technological change and hedging, but have chosen not to focus on these aspects.
The level of exploration expenditure continues to fall, although the rate of decline is slowing, as has been the trend since 1993 as documented by Metals Economics Group (2000). This study has been updated with small junior company exploration budgets back to 1995, and is now estimated to cover 90% of worldwide exploration.
The mix of exploration expenditure by region and among commodities is worth noting in Fig. 1 and 2. Interestingly, although all regional exploration expenditures have fallen from the 1996 and 1997 highs, numbers in Canada and the Pacific/Southeast Asia region actually increased in 2000. It is also interesting to note that, while the percentage of gold exploration has fallen, it has not fallen as dramatically as one would expect given the overall performance of the commodity.
It is apparent that exploration expenditure tracks commodity price given appropriate lags in timing associated with planning. A significant component in exploration expenditure is that junior mining companies are heavily dependent on the equity markets for financing.
The level of public equity market raisings in mining since 1990 makes similar depressing reading. Although the number and value of mining equity raisings of less than $10M have increased in the last two years. As the average size of all mining equity raisings has fallen from $19.5M in 1994 to $4.5M in 2000, the increase in smaller financings could have been due to the fact that companies, which might have at one point in time, raised greater than $10M are forced to take what they can get at less than $10M.
It is worth noting the level of equity raisings in the early 1990s. The question is, "Are the mid '90s 'normal' conditions or were they the good times?" There is no answer for this, but do know that investors are becoming more discerning and short term with investment decisions.
There are many reasons for the decline in available capital, including:
a. Competition for capital--the "new" economy;
b. Performance of the indus- try--the industry is perceived to be "post" growth and one that offers poor returns; and
c. Commodity Price-we can not do anything about this, or can we (through marketing)?
COMPETITION FOR CAPITAL
The authors feel uniquely able to discuss the competition for capital question, given their active involvement in raising private equity for Resource Capital Funds over the past three years.
The private equity market is a source of significant capital, provided by institutional investors, endowments, family offices, and high net-worth individuals. These investors seek diversification and high returns for funds they allocate to alternative investments (generally 5-10%) as a hedge against their primary investments.
During the past three years, the total amount of funds raised by U.S. private-equity limited partnerships in the form of buy-out, mezzanine, and venture capital funds was (Private Equity Analyst, January, 2001):
Year $B 1998 92.2 1999 95.5 2000 153.9
Resource Capital Funds has been able to raise $120M in private equity over this three-year period. Other than another private equity fund sponsored by Quebec's Caisse de Depot (Sentient), there are no other mining-related private equity funds that we are aware of.
While private equity is significantly more "return" orientated, the same issue applies when addressing the concerns of traditional institutional equity investors.
The mining market, as a proportion of the total equity market, is also declining. This is a combination of a higher rate of growth of new industries, but also non-traditional valuation methods that inflate these sectors' "equity" value.
Mining also suffers from a decline in market share, particularly recognized in Canada. Between 1995 and 2000, the value of the mining component of the TSE 300 has declined from 20% to less than 5% (Cooper, 2001).
On a larger scale, total market capitalization of global equity markets has risen from $9.8B in 1990 (Congressional Press Release, 1999) to $35 trillion in 1999 (FIB V.com, 2000). After, once more, being a significant component, Fig. 4 demonstrates that mining, at $320B, now represents just 1.7% of total world market capital (Bloomberg, 2001). In fact, mining has a smaller market capitalization than an individual company: GE ($450B), and just a slightly larger total market capitalization than Microsoft. Interestingly, just one year ago, Microsoft's market capitalization was twice what it is today (Bloomberg, 2001).
Despite the increased demand for commodities that are consumed by the technological devices being developed and rapidly consumed by a technology-hungry generation, the mining industry has been dwarfed by dreams of the "new" age during the great technology bull market. Perhaps the harsh reality of a Silicon Valley with no commodities to build, or power to drive, is that its computers will help balance the weighting of forgotten primary industries, such as mining.
Beyond size of both the industry as a whole and individual companies within it, the fund manager needs to see return potential. Granted, the industry is plagued by its post-growth perception, but also by its history of poor returns. To compete with other sectors, the mining market needs to focus more on things such as return on capital as a measure of corporate performance.
During the 1990s, the broad market focused on earnings and revenue growth as the major driver for share valuation. Unfortunately, during this same period, many mining companies ,gold companies in particular, focused on production growth rather than earnings or cash flow and cash costs of production rather than total or break-even costs. These companies clearly ignored the bottom line and issues such as those associated with the cost of, and return on capital.
To attract capital, the mining industry needs to improve its "return" to investors. Return means different things to different people, and, at the same time, the same concept is referred to with many variations and a number of proprietary names that add to the confusion. In assimilating the lot, it appears that there are three basic concepts: i. accounting returns; ii. economic value added; and iii. returns to shareholders.
i. Accounting Returns: These are numbers derived directly from financial statements, such as:
* Return on Equity (ROE);
* Return on Invested Capital (ROIC); and
* Return on Capital Employed (ROCE).
While some sectors of the industry provide very attractive ROCEs, other sectors provide very low ROCEs. At least the industry weighted average ROCE exceeds the industry's cost of capital, but not by much. It is worth noting those sectors of the industry with attractive returns when the consolidation of the industry is later discussed.
ii. Economic Value Added: A concept used to measure the true economic profits of a firm after operating costs and cost of capital (Gulley, 2000)
HSBC's November, 2000 North American Gold Review defines the variation 'Appraised Value' as the sum of capital invested in operating the business and the present value of the expected economic profit (HSBC, 2000). For commodity-based industries, HSBC adds the option value for higher commodity price effects on reserves.
iii. Return to Shareholders: Some will argue that the only return that matters is that enjoyed by shareholders. Investor returns are a combination of capital gains or losses, as measured by share price appreciation or depreciation, plus the dividend yield.
The intent is to not focus on the pros or cons of relative return definitions, although strong accounting returns typically lead to good returns for shareholders. The point is that, relative to other industries, by many measures of return, the mining industry as a whole has a poor historical record. Individual companies may do well, but that misses the point that, these days, investors assess the industry as a whole prior to selecting individual companies within it. The companies providing a better return need to do more to "carry" the poor performers, or the poor performers need to shape up or shut down. However defined, the industry as a whole needs to achieve returns that exceeds its cost of capital.
In a paper entitled, The Economic Performance of an "Old" Industry: Mineral Extraction and Processing, Rob McDonald, managing director of NM Rothschild & Sons Ltd. (Australia), states that the mining industry has generated an average compound real rate of return to shareholders of just 5% over the past 25 yr (McDonald, 2000). Also discussed is the fact that the real U.S.-dollar cost of capital for the mining industry over the past 25 yr has been between 7% and 8%/yr. The industry needs to improve if it is to attract equity capital. The industry is competing with other industries and needs to lift its collective performance. There also needs to be less internal competition. The way to achieve adequate returns in a macro sense is greater financial discipline when making investment decisions.
The concept of relative industry performance leads to a related issue of consolidation. Most commodity prices (sans gold) are a function of supply and demand. In good times, companies make individual decisions to develop a new source of supply. With more players, you get several new mines opening at the same time, because each company takes the then-current commodity price and determines whether its project provides the required return based upon its individual criteria. Three or four companies making the same independent decisions results in over-supply or excess capacity. As the chief economist of Rio Tinto recently stated, "An appropriate strategy needs to start out from an acceptance that we are a slow growth industry, but that it is, nevertheless, still possible to make attractive returns by being rigorous and realistic in creation of new capacity and then by operating the industry as close as technically possible to the frontier of that capacity." To address this issue, control of production needs to be come more concentrated. Concentration of production also has the added benefit of achieving critical mass from an investor's perspective.
The consolidation process is well underway. Fig. 7 above depicts gold and base-metal acquisition value versus commodity price trends for the years 1993 to 2000 (Metals Economics Group, 2001). Clearly, commodity price increases influence the amount of consolidation.
For another perspective, the reader is referred to an insightful ABN-AMRO brokers' report, dated Aug. 24, 2000, entitled, Industry Polarization (ABN-AMRO, 2000). The following conclusions of this report are very valid:
* "The top eight mining companies represent 75% of the capitalization of the global mining sector (excluding precious metals), up from 52% in 1998." This represents M&A activity, but also a market premium for size and liquidity.
* Top eight companies by market capitalization:
2. Rio Tinto
3. Anglo American
6. De Beers
* This top eight represents 80% of the value of M&A activity since January 1998.
* The focus of the top eight companies is premium (high margin) commodities:
* Borderline premium business lines are:
The ABN-AMRO report shows that nickel and zinc are low margin businesses, but these commodities could have improved margins with more consolidation and financial discipline. Granted, the ownership of nickel is high, but not within the top eight companies.
Fig. 8 and 9, from the same report, are also instructive. Industries with significant concentration of production achieve higher operating margins and returns on capital employed.
Another way of looking at the need for consolidation in weak commodity businesses like gold is put forth by Barry Cooper of CIBC World Markets (Cooper, 2001). Fig. 10 shows that, in comparison to fairly well consolidated commodities, such as nickel, aluminum, and copper, where just five to six companies make up 50% of market share, it takes as much as 16 companies to make up 50% of the market share in the gold business. Clearly, gold is a candidate that could benefit from consolidation.
However, as Sir Robert Wilson, chairman of Rio Tinto, has warned, "...consolidation alone is insufficient, and the industry needs to change its behavior with regards to excess capacity."
What does this consolidation mean for junior companies?
At the end of the day, the role of junior companies remains the same. They are the risk-taking pioneers into hostile, or unorthodox territories and they are, more and more, becoming the grassroots explorers for the entire industry. In essence, juniors are the R&D of the mining sector. Their role in the whole process is to find and define ore bodies to replace production.
In cases where consolidation does not make sense (non-synergistic commodities) or is prohibited for competition reasons, the mining industry is banding together in different ways in order to become more competitive. A number of major mining companies have established Quadrem, an electronic marketplace designed to coordinate industry purchasing. There is also more talk of mimicking De Beers' success in marketing diamonds, with similar marketing campaigns for gold and other commodities.
Despite some of the issues that plague the industry, the mining sector is a slow and steady growth story. The difficulty is portraying the positive aspects to the general public. During marketing for Resource Capital Funds, there were many views of the mining industry, including:
* It is a non-growth sector with wasting assets;
* It is environmentally irresponsible;
* It offers poor returns; and
* Commodity prices fall in real terms.
Clearly, based on these common outsiders' opinions, the mining industry appears to have lost the public relations battle to date. However, the mining industry is much more environmentally and socially responsible than the public gives it credit for. Many companies are becoming proactive in these areas and the industry has established the "Global Mining
Initiative" (GMI). This study, which is being sponsored by 27 mining companies, as well as non-industry participants, seeks to incorporate all stakeholders views with respect to sustainable development. Unlike previous studies, the GMI has employed unbiased, non-mining industry consultants to conduct the study.
MINING VS. THE NEW ECONOMY
There have been several recent comments on the role of metals in the new economy. This fact is emphasized when one considers the key mineral-derived constituents of a computer.
The growth in mining is global and has similar underpinnings to other growth sector such as telecommunications. In Fig 12, several aspects of the mining and telecommunications industries are compared and contrasted, while Fig. 13-16 highlight the similarities of a number of aspects of the two businesses.
Fig. 13 shows recent historical and forecasts consumption growth of refined copper, while Fig. 14 shows the growth of U.s. minutes of international telephone service for selected international points.
The "Intensity of Use" curve for copper in Fig. 15 suggests that as developing countries move up the curve, they will consume more and more copper. A similar trend would be expected for telecommunications use.
Fig. 16 demonstrates the argument against the mining industry that commodity prices are declining in real dollars. Anyone who has paid long distance phone bills for a decade or more will understand that the exact same, although less volatile, trend is evident in the telecommunications industry.
Everything begins with mining, but its significance has been shrinking. The industry needs to focus on returns in order to win back previous advocates of the sector and attract new ones. In doing so, the industry must manage the supply side with financial discipline and a certain amount of consolidation. At the same time, the demand side must also be addressed with more of a focus on marketing for all commodities. Above all, the industry must redefine the public's perception of mining if it is to regain its historical significance in the world economy. As demonstrated by the telecommunications example, we are not that different from other sectors that have recently thrived.
(*)Presented at the 2001 Prospectors & Developers Assn. of Canada Convention
Annual Statistics. FIBV. corn. 2001
Base Metal & Gold Acquisition Services (Internet). Metals
Economics Group. Halifax: 2000.
Blake, Linda and Laude, Jim. Trends in the U.S. International Telecommunications Industry. Federal communications Commission. Washington: 1999.
Cooper, Barry. What's Up and Down In the Gold Sector. CIBC world Markets. Toronto: 2001.
Congressional Press Release -- Oct. 14, 1999. Federal Document Clearing House. Washington: 1999.
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Cost of Capital to the Mining Industry 1999 Edition. NM Rothschild and Sons (Australia) Limited. Sydney: 2000.
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Industry -- Some Observations. CIBC world Markets. New York: 2000
Industry Analysis Division -- Common Carrier Bureau. Trends in Telephone Service. Federal Communications Commission. Washington: 2000
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Figure 2 Target Commodities As a Percentage of Worldwide Exploration Gold Base Metals Diamonds Other 1996 60.7% 29.7% 7.2% 2.4% 1997 64.6% 26.7% 6.2% 2.3% 1998 58.3% 31.9% 8.8% 1999 51.9% 34.7% 10.0% 2000 46.6% 37.9% 9.6% Source: Metals Economics Group Note: Table made from bar graph Figure 4 Total World Market Capitalization Mining 1.7% Non-mining 98.3% Source: Bloomberg, FIBV Note: Table made from pie chart Figure 12 Mining Telecomms Telecommunications Total Market $317B $3,966B Capitalization (Feb. 9, 2001) (Feb. 5, 2001) (date data derived) Top 8 Companies' 75% 25% Representation of Total Industry Market Capitalization Average Industry 9.6% 18.5% ROE (ABN-AMRO 2000 est.) (ave/ N. Amer. price cap co's - FCC) (note: this is a regulated industry) Unit of measure for $/min. long comparision: $/lb Cu distance rate Source: Bloomberg, ABN-AMRO
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|Author:||McClements, James; Cranswick, Russ|
|Publication:||E&MJ - Engineering & Mining Journal|
|Date:||Nov 1, 2001|
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