The mining industry is having a confidence crisis, according to PWC. In their 2013 report, Mine: A confidence crisis, they state "volumes are up, dividend yields are up and commodity prices have fallen, but not crashed. Long-term demand fundamentals are still there. So what’s the crisis?" In this article we will summarise the outlook of the mining industry and explore why the sector is facing such a crisis in confidence.
Broadly, the issue of confidence crisis boils down to some key areas that the markets have lost faith in. These areas include costs, commodity prices and resource nationalism. As such, the markets are reflecting this lack of confidence.
Investors fear the increasing costs faced by mining companies will not be brought under control, and this fear is not without merit as between 2010 - 2012 the top 40 gold producers saw their gross margins fall from 49% down to 29%. Such a significant drop in margins soon eats away at the benefits gained from a high gold price.
At the peak of the industry, mining companies were chasing short-term gains to deliver results for shareholders by chasing volume growth over productivity. Much of the capital outlay on these projects has failed to deliver a substantial return. As such, investors want discipline employed over capital expenditure with a return to focus on productivity over volume. “We’ve put an extreme focus on issues of productivity and capital discipline, which really are very close to my heart.” - Andrew Mackenzie, CEO, BHP Billiton
Returns on capital employed
An important indicator for industry performance is returns on capital employed (ROCE). In the pre-2008 boom, this figures peaked at around 23% after several years of steady growth. In 2012, ROCE dropped to just 8%, its lowest level since 2003. Operating costs across the industry have risen faster than many industries meaning moderate price increases are not enough to cover the increased costs.
New projects on the horizon
Getting control of the capital expenditure is critical and this means investment in new projects is being squeezed. Getting more bang for their buck is important to the top 40 mining companies with some stating that only projects with a 25% return will be pursued. Along with an increased focus on capital expenditure, investors want to see increased returns in the form of dividends. There is good news for investors here as dividends have increased more than 150% between 2009 -2012.
One of the looming concerns for the industry is the increasing level of resource nationalism. As the price of commodities increases, governments around the world are seeking a bigger slice of the profits generated. Tactics used by governments range from increasing taxes and royalties to restricting foreign ownership of mining rights.
As ever, changes are well underway within the industry to address these concerns. Five of the top ten mining companies have hired new CEOs and the long-term fundamentals appear to be in place so the outlook is not all bleak. Either way, Mirage Machines will continue supplying some of the on-site machine tools to the world's big mining companies to ensure maximum performance of on-site assets.
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