Mining Slump Feeds M&A as Projects Overrun Budgets
Wednesday, 23 May 2012
The world’s largest mining companies led by BHP Billiton Ltd. (BHP) are struggling with higher costs to complete $200 billion in new projects, prompting them to slow work and turn instead to acquisitions and asset sales.
BHP and Rio Tinto Group (RIO), ranking first and third by sales, this month said they’ll ration capital spending because of escalating costs and a slower-than-expected global economy.
"It’s been ‘build’ for quite some time, and now it’s pushing much more in favor of potentially ‘buy’ because there are bargains out there," Michael Elliott, Sydney-based global mining and metals leader at Ernst & Young LLP, said by phone.
Lower metals prices have made targets cheaper and spurred mining companies globally to announce $91 billion of deals in the year to date, up from $71.2 billion in the same period of 2011, according to data compiled by Bloomberg. First Quantum Minerals Ltd. (FM), African Minerals Ltd. (AMI) and Coal of Africa Ltd. are potential takeover candidates, Liberum Capital Ltd. said.
The Bloomberg World Mining Index (BWMING) has lost 23 percent from its 2012 high in February, raising investor concern of an end to the bull market that increased commodities as much as fourfold since 1999, with price gains in 11 of the past 13 years.
"The market is increasingly pricing in the end of the super-cycle," Liberum analysts Dominic O’Kane and Richard Knights said last week in a report. "The majors are re-thinking organic growth plans versus M&A as valuations fall."
BlackRock Inc. (BLK), the world’s biggest asset manager, trimmed its holdings in BHP following concerns the company’s Olympic Dam project and shale assets may curb returns. A drop of as much as 50 percent in mining company valuations since last year, while capital spending costs gain 25 percent a year, has shifted the balance in favor of acquisitions and mergers, Liberum said.
"If the capital cost of bringing those projects through overruns starts eating into those returns, then other growth scenarios which include M&A become more attractive," Ernst & Young’s Elliott said.
Teck Resources Ltd. (TCK/B), Canada’s largest diversified mining company, last month said it’s interested in entering the iron- ore industry and would seek to acquire a producing asset rather than develop a mine.
Global spending on new production will drop 19 percent to $103.8 billion next year, according to a May 2 report from Bank of America Corp., dubbing spending cuts the "new paradigm" as mining companies focus on safeguarding returns to shareholders.
Metal prices in London have plunged 13 percent from this year’s high on Feb. 9, after optimism of a global economic recovery was dented by China’s decision in March to cut its growth forecast. The cost of building mines in Australia, the biggest exporter of iron ore and coal, has risen as much as 100 percent, according to Rio Tinto.
Commodities, as measured by the Standard & Poor’s GSCI gauge of 24 raw materials, still remain more than threefold above their 1999 levels. About half of this year’s $91 billion in announced deals comes from Glencore International Plc (GLEN)’s $45.3 billion stock offer for Xstrata Plc (XTA), according to data compiled by Bloomberg. Copper producers First Quantum and Kazakhmys Plc (KAZ), iron ore miners African Minerals as well as London Mining Plc and coal companies Adaro Energy and Coal of Africa are among possible takeover candidates, Liberum said.
BHP, already selling its Richards Bay minerals business in Africa and its diamond unit, may also dispose of its aluminum and manganese businesses as well as some coal assets in Africa, Australia and America, Bank of America said in a May 2 report.
BHP spokeswoman Kelly Quirke declined to comment on falling valuations making takeovers more attractive. Bruce Tobin, a Melbourne-based spokesman for Rio Tinto, also declined to comment.
First Quantum is trading at a multiple of 9.3 times earnings compared with 10.1 a year ago, while Kazakhmys’ price- to-earnings ratio has almost halved to 4.4 times, data compiled by Bloomberg show.
"The price of building new projects means that in many cases it might be cheaper to acquire a company than build your own," Andrew Harrington, a resources analyst with Patersons Securities Ltd., said by phone. "The biggest ones would be coal, copper and gold, each of those three are trading at about a 30 percent discount to the commodity price."
Recent examples include Iamgold Corp., a Canadian producer of the precious metal, agreeing to buy Trelawney Mining and Exploration for about C$585 million ($573 million) on April 27 and Sumitomo Corp. buying a 50 percent stake in Aquila Resources Ltd.’s Isaac Plains coal mine in Australia for A$430 million ($421 million) April 3.
BHP, which spent $20 billion buying shale assets last year, had the balance sheet capacity to continue to make more acquisitions, Chief Executive Officer Marius Kloppers said in February. Anglo American Plc (AAL) Chairman John Parker said in March the company continues to examine merger and acquisition opportunities.
Fortescue Metals Group Ltd. (FMG), Australia’s third-biggest iron ore producer, would appeal to Anglo and Teck, according to RBC Capital Markets. It may also be a target for Glencore after it buys the rest of Xstrata in stock, RBC said.
Bull Market Ending?
The 14-year bull market, or supercycle, in commodities may be coming to an end as interest rates move to "more normal levels," Longview Economics Ltd. said last month. Mining companies operating in Asia are facing lower cash flows as prices retreat from "stratospheric" levels, credit rating company Standard & Poor’s said in a May 3 report.
"For the base metals sector, we think the peak is behind us," Nikos Kavalis, London-based metals strategist with Royal Bank of Scotland Plc, said by phone. "Although we expect higher prices we don’t expect a return to previous peaks."
BHP, Rio Tinto, Xstrata, Glencore and Anglo may spend a combined $200 billion on building new production over the next five years, Liberum said. Some of this spending may come under review as prices decline from records, the analysts said. BHP will fall short of a five-year spending target of $80 billion on new mines and expansions because of slower growth in China, political gridlock in the U.S. and the euro-crisis dampening the recovery, Chairman Jac Nasser said May 16.
"You still have high metal prices, the problem is the margins are getting eaten into by cost inflation that is running rampant in the industry, as high as between between 8 and 10 percent per annum for some miners," Jeff Largey, a mining analyst at Macquarie Capital Ltd. in London (LMEX), said by phone. "As you grow you’re actually paying more in terms of your capex per ton and your returns thus diminish."
To be sure, rather than buying assets in production, trimmed spending plans may prompt BHP to use the surplus cash for a new share buyback, RBC’s London-based analysts Des Kilalea and Richard Hatch said in a May 18 report. BHP completed a $10 billion repurchase plan last June and Rio Tinto finished a $7 billion buyback in March.
"Companies like BHP have cash flow coming out of their ears but anything beneath you would probably want to hold on to your funding" because of cost pressures and increased difficulty in agreeing on debt funding with banks, Harrington said.
BHP’s board is due to decide on the development of three major projects -- an iron ore expansion at Port Hedland in Western Australia, the Olympic Dam copper and uranium mine in Australia and the Jansen potash mine in Canada -- by the end of this year that may cost a combined $55 billion to develop, Liberum said. BHP may choose phased expansions for Jansen and Olympic Dam, Largey said.
Rio Tinto, outlaying more than $33 billion on expanding output, will narrow spending, Chief Executive Officer Tom Albanese said May 10, citing a weaker global economy and cost increases of as much as 100 percent.