Pulse Check – The Global Mining Industry
Holy commodity Bear market! And just in time for the New Year. Here we are with Gold around $1280 and Oil at $48, and Silver and Copper are not showing much interest in moving any higher.
Despite the recent fixation on the tribulations in the oil market, I’ve dug out some numbers and provided a brief commentary on the state of the mining industry. I focused on the extent which Canadian Miners have bruised investors’ portfolios, how these companies have substantially levered up over the past couple years, and how they are still not ready to begin picking up projects on the cheap.
As with most (all) commodity driven companies, when things are good, they are good, but when they are bad, it gets real ugly. This is where we are today in the mining industry. The ugly. It’s tough to point out a winner in the industry over the past couple years, and downward revisions on stocks have become a norm. The above chart doesn’t properly display the carnage that has been felt by resource investors, especially junior mining investors in recent history. Although Gold has caught a bid since November of last year, metal prices more generally can’t seem to break trend, and aside from very brief periods of renewed optimism, things have been pretty terrible for the industry. Of course there have been some decent performers, with reputable management teams (I point to Klondex Mines (KDX-T) as a recent example), but over the past 3 years the majority of investors have been taken for a ride where the only direction has been down.
One of the industry’s systemic issues is that there are still too many marginal projects that aren’t feasible at current metal prices. NAVs continue to be reduced as price estimates become less rosy, and companies are writing down their projects in big ways. We’ve also seen rampant cost inflation at the majors, coupled with juniors’ bank accounts approaching dangerous levels. All this has led to industry wide underperformance and more reasons for investors to turn away from mining stocks with unreliable operations and far-out cash flows.
The data is a bit dated, but the punch line remains the same.
So how have companies responded to the bear market? In general, with spending cash, and taking on more debt. Since November 2012, a year that still carried quite a bit of mining market optimism, Canadian listed mining stocks alone have destroyed at least $90 Billion dollars of shareholder value. Cash levels of TSX Index miners have also decreased by over $7 Billion in aggregate, and debt levels have increased by over $16 Billion. It’s worth noting that these figures are without the companies that haven’t been taken out of the index – my guess is that the numbers likely look worse for the industry as a whole.
Toronto Venture listed miners haven’t had it much better. Although debt isn’t as much of a factor, cash levels are bottom of the barrel, and index de-listings are becoming more commonplace. The reality is that most juniors are in a real tight spot with few viable options – to survive the next 12-18 months they can dilute current shareholders beyond recognition, or hope a larger company takes interest in their resource. Neither sounds like attractive options at this point, and both are becoming more difficult.
I find it interesting to see that companies have levered up far past the top of the mining Bull Run a few years ago. Maybe they saw the writing on the wall and decided to bolster their balance sheets, or maybe some of them really did intend on purchasing distressed companies if markets turned, but whatever the case is, their financial positions are no better off than a few years ago. Although the larger players should theoretically be in a better position to pick up assets at the bottom, this has largely not been the case. Contrasting the current sentiment to just a few years ago, the optimism in the mining sector was really something. It seemed that most companies with a resource (or potential resource) could cash up or be acquired by one the majors fairly quickly.
As I began to dig through some Bloomberg screens, I thought that as the industry began to bottom out that we should see an associated increase in M&A activity – companies are cheap, so the bigger players will use their flexibility to consolidate some of the industry’s projects. This has not happened. So what have mining companies been doing? As aforementioned, there has been a substantial decrease in cash, increase in debt, and reduced M&A activity in the industry. Essentially, companies are trying to survive and stay profitable in a potential long bear cycle.
I don’t think my quick Bloomberg screen will capture all Global M&A activity in the industry, but it’s a good proxy to make a few quick observations. Since 2011, M&A deal activity is down substantially – cumulative dollar value of deals has also been very weak. 2014’s cumulative deal value may look like a rebound, but over half of it is made up of Osisko related transactions. It looks like the majors aren’t ready to open their balance sheets yet, which likely reflects a fear to deploy a substantial amount of capital for marginal projects, as well as the fact that their focus has been on reducing production costs.
Is there a read-through?
Will we see the same fate for the oil industry? Perhaps. I don’t think it’s a stretch to think that oil prices will remained subdued until less economical, higher cost producers are temporarily cleansed from the industry. But what about M&A activity? Are the large oil producers going to have the same fundamental strategy in this downturn as the miners? It would be unfortunate to see the well-positioned players lock up their balance sheet and miss strategic opportunities, but it’s also possible that it will be different – there is already some optimism brewing from the recent Talisman transaction.
For the mining industry, the data hint that we are still a long way out from seeing a true bottom. Larger companies are still too levered to make meaningful purchases, and there are still too many uneconomical junior deposits hanging around. Without a substantial upward movement in commodity prices (Gold in 2015?), which isn’t looking like a great bet so far, the industry simply needs these marginal companies to disappear. The reality is that this will take years to happen. A lot of issuers are barely holding on, but a cleanse of this proportion is going to take some time. So even though we have seen some dark days for the miners, it will continue to be a tough road ahead.