Miners look to unearth best cost-cutting opportunities
After a year when commodity prices dived, the industry has refocused and is slowly returning to strength, reports Jon Yeomans
‘It’s been a very long and painful hangover from the binge on spending and acquisitions’
The mining industry is in reboot mode. After the misery of 2015 – when commodity prices hit freefall, share prices plunged and assets were written off – the sector is tiptoeing back to health.
The four big, diversified FSTE 100 miners – Glencore, Anglo American, BHP Billiton and Rio Tinto – have all opened their books in the last month, keen to show investors they have a strategy and are sticking to it.
In the absence of fireworks, the miners talk of “efficiencies” and “discipline”. “Boring is the new excitement,” Rio Tinto’s chief financial officer, Chris Lynch, told investors earlier this month. “We could be boring for a long time,” added his boss, Jean-Sébastien “J-S” Jacques – a comment all the more remarkable for it being his first outing as chief executive.
Is being boring a virtue for the big miners? And can it pave the industry’s road back to growth?
The unlikely theme of the miners this month has been trucks: big trucks. The chief executives of the big four all pointed to their haulage vehicles as examples of how they are squeezing more out of their operations, by keeping them on the road for longer. “As we get more out of trucks, that helps reduce our capital,” explained Mark Cutifani, boss of Anglo, which says it has cut operating costs by 36pc since 2012.
Andrew Mackenzie, BHP’s chief executive, talked of the “inexorable pursuit of reducing costs”, explaining how his engineers zap inefficiencies in the system. “We target bottlenecks and try to lift them,” he said. “It’s not rocket science,” said Steve Kalmin, chief financial officer of Glencore, while admitting that “some of these things feed in passively” – in other words, through foreign exchange gains, when local currencies depreciate, making operations in those countries cheaper.
The obsession with costs is a consequence of the miners’ spending spree during the “supercycle” – the decade from 2002 when China’s economy expanded, fuelling demand for raw materials, and sparking a bonanza in mining.
But as China cooled down, excess supply hit the market, leading to a plunge in prices. Since around 2013, the miners have been tightening their belts.
“It’s been a very long and painful hangover from the binge on spending and acquisitions during the supercycle,” says Alon Olsha, an analyst at Macquarie. “The industry was really forced by lower commodity prices to cut back on capex and costs, to restore balance sheet integrity.”
As dividends have been slashed and profits have evaporated, cost cutting is one of the few things miners can shout about. “Companies have been talking up cost savings as right now there isn’t much else to talk about,” says Myles Allsop, of UBS. But such a stringent diet can make the stock less palatable. “From an investor’s point of view, cost savings are rarely the best reason to own a mining company,” Allsop adds. “In an oversupplied market, most gains achieved in savings are given back to the customers in lower prices.”
Most people accept that a clampdown on costs was overdue; the sheer amount of cash saved proves miners had become flabby. Moreover, the boom era left most of them heavily indebted.
But as prices have rebounded in 2016, and the miners have begun to heal themselves, the question is being asked: where is future growth going to come from?
Glencore boss Ivan Glasenberg points out that the combined capital expenditure of the top five miners this year of around $20bn to $25bn (£15bn to £19bn) is equivalent to what one of them would have spent in earlier years. “In all my time in the industry I can’t recall a time when there were no new mines being built,” he said.
The state of the industry can almost be measured by the number of projects that are not going ahead. Rio Tinto has puts its giant Simandou iron ore scheme in Guinea to the sword, and last week cancelled long-gestating plans for a diamond mine in India. It is, however, pressing ahead with the $5.3bn expansion of its Oyu Tolgoi copper mine in Mongolia, one of the biggest projects anywhere. BHP, for its part, continues work on its Jansen potash mine in Canada, but warned that it could be mothballed if fertiliser – for which potash is used – does not recover in price.
Greenfield development – building mines on virgin land – is largely off the table. Instead miners are looking at brownfield options, adding capacity at the mines they already have, or sweating their assets harder. “What we want is to drive productivity,” said Jacques of Rio, which is looking to save $2bn in 2016 and 2017. “It is really about: how can we extract more cash flow from our existing assets?”
For Cutifani, the watchword is “value”. “We are not sitting on our bums working simply on cost reductions,” he insisted. “It’s about efficiencies and… hitting our capital deployment in every way we can, to create value.”
With many commodities still oversupplied, and prices still way below their five-year averages, the trick for the miners is to grow their businesses without adding to the world’s stockpiles of metal. The logical answer is to grow market share through acquisitions – but M&A, it seems, is not yet on the agenda.
“Many companies are still licking their wounds from mistakes they made in the past and keeping their powder dry,” says Olsha, who points that M&A in mining doesn’t always achieve the cost savings it would in other industries. “The only way to make it work for shareholders, without making an explicit call on [which commodity is going to boom], is to extract synergies, and that’s not easy – often mines need to be adjacent to each other, for example.”
It’s a matter of debate whether mining is in a buyer’s market. When Anglo announced a huge disposal programme at the end of 2015, analysts warned it would struggle to achieve a good price for its mines. But Cutifani confounded critics by selling his niobium and phosphates business for the $1.5bn asking price; the buyer was China Moly, a player with deeper pockets than some of the traditional mining groups.
Pressed on M&A, mining bosses say the same thing: they are always looking for deals. But quality assets are hard to find. “We always look at everything,” Glasenberg said last week. “We don’t see anything right now that we’re seriously looking at.” Mackenzie said he had an “aggressive plan to grow the company without any acquisitions”. Jacques, for his part, said: “Before we trigger anything it would have to be about the quality of the assets, and does it make any sense for our shareholders?”
None the less, all four of the big FTSE miners have assets for sale as they slim down their portfolios. “Meaningful acquisitions” could be on their way – but not for another year, reckons Allsop.
Meanwhile mines are getting older, grades are falling, and supply in some commodities could begin to tighten – potentially boosting prices. “If you take a three to five-year view, you could start to see some deficits building,” Allsop says. “It’s sowing the seeds for the next cycle.”
As sure as mining is a cyclical business, so the “boring” era is likely to be a temporary, but necessary, phase.
However in one aspect, miners would be quite happy to be boring – or at least uneventful.
Of the big four miners mentioned here, Glencore and Anglo both reported fatalities in the first half of this year. Every briefing from a mining company starts with an update on safety. “We say ‘safety’ 10 times more than ‘productivity’,” as Mackenzie put it. The challenge, on this score, is to have nothing to report at all.