Boring does it

Mining shares may be back on the screens of investors globally, but they are not viewed with quite the same sense of unbridled enthusiasm of the early Noughties.

A report by S&P Global Market Intelligence in October said that while exploration budgets among non-ferrous mining firms (those digging for gold and base metals such as copper) was on the increase for the first time in five years, miners were predominantly sticking to the limits of their existing mines, so-called brownfield expansion.

A report by S&P Global Market Intelligence in October said that while exploration budgets among non-ferrous mining firms (those digging for gold and base metals such as copper) was on the increase for the first time in five years, miners were predominantly sticking to the limits of their existing mines, so-called brownfield expansion.

What this means is there isn’t yet enough confidence among miners or lenders to go boots and all into greenfield mine developments.

In the case of building new mines, the lead times are longer, they are more expensive, and investors are still jittery about the minerals and metals market.

“Although improved market sentiment over the past 18 months seems to have slowed the decline in grassroots share of budgets in 2017, another year of increase in the minesite share reflects a near-term focus by many producers, as well as a persisting climate of risk aversion,” said Mark Ferguson, associate director of research, metals and mining at S&P Global Market Intelligence, in the report.

Speaking at the Joburg Indaba in October, prominent asset managers charted the recent history of poor returns and underperformance from mining stocks – and not just those in SA where country risk is an unignorable factor.

“For 15 years flat the resource index has been the worst performer,” said Henk Groenewald of Coronation Asset Managers. “Why is that, given the China-inspired market?” he said of the pace of China’s consumer-driven industrialisation from about 2002 to 2011.

“The big failure is that mining companies failed to look long term and to recognise the cyclicality of the commodity market.” Some investors think mining executives are directly to blame.

In the view of Jamie Horvat, lead manager for M&G Investments, the multibillion-dollar UK asset manager, miners believe themselves to be of a slightly different class to the rest of investment society.

Astonishingly, Horvat said: “We have difficulty getting the mining executives to meet with our teams. We are able to sit down with Apple executives but mining bosses seem to think of their firms as belonging to them.”

Said Jim Rutherford, a former asset manager and now a non-executive director on the board of Anglo American: “Mining firms saw themselves as occupying a space of different reality where the normal economic laws were suspended,” he said.

Another issue affecting the way mining firms perform is the unique circumstances and risks that come with the activity of physical extraction; that is, the disruption of digging the earth: community, environmental and political risks abound.

These factors certainly seem to weigh heavily on the ability of miners to provide returns, as demonstrated by PwC in its recently launched survey, SA Mine 2017. While the mining industry continues to add value to all its stakeholders, it’s the equity holders – the shareholders – who benefit the least, said the auditing firm.

This is true in SA and elsewhere. As set down in company value-added statements, employees still take the lion’s share of value added at 40%, followed by government through direct taxes, payroll and royalties with 19%.

“It is disappointing to note that shareholders got only 2% in the form of distributions,” said Michael Kotzé, PwC’s leader of Africa Energy Utilities and Resources. “I call it the four Ss,” said Rutherford. “Whenever you saw strategic, synergies and shareholder value being spoken about in a company announcement, you knew it was time to sell (the fourth S)”.

Horvat is critical of the financial engineering that went into company results rather than the business of creating net present value – building fundamental value to the assets under the mining companies’ control.

This is the building of balance sheet debt in order to conduct merger and acquisition activity – the kind of corporate decadence that was par for the course during the heady days of the mineral super cycle.

So what does a mining company worth investing in look like?

“They must be boring,” said Frank Beaudry, an investment analyst at Capital Group, the US-headquartered firm with some $1.5tr under management. Investors want stability, the ability to deliver on targets and no nasty surprises.

According to Horvat, Mark Bristow, CEO of UK-listed Randgold Resources, does the right things by generally resisting expensive merger and acquisition strategies and investing in renewing the firm’s gold resources through grassroots exploration.

No resource is developed into a mine unless it can survive at a gold price of $1 000 per ounce – which Horvat believes is conservative, sensible and supportive of the company’s net present value.

This article originally appeared in the 2 November edition of finweek. Buy and download the magazine here.