Glencore M&A doesn’t mean miners have returned to old ways

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DAYS after concluding the recapitalisation of its balance sheet, and reinstalling the dividend, Glencore boss, Ivan Glasenberg, announced a proposal that the Swiss-headquartered company would join Qatar Investment Authority in a $12bn swoop on shares in Russian oil producer, Rosneft.

A couple of months later, it agreed to pay $534m for the shares it didn’t already own in Mutanda Mining, a copper and cobalt producer in the Democratic Republic of Congo. This was quickly followed by a $10.3bn tilt New York-listed agricultural trading giant, Bunge, and then a high-stakes play for the Australian coal assets of Rio Tinto, Coal & Allied (C&A).

The latter two transactions were rebuffed, but if investors were seeking a sign the commodity slump was nearing its natural end, then Glencore’s outward-looking growth strategy was it – an expression of financial health regained following 18 months of shrivening austerity.

According to Investec Securities, the mining market is in full swing again. The big hand of its entertaining ‘Mining Clock’, a diagrammatic representation of the commodity cycle, had swept through four and five o’clock, representing a period of asset write-downs, rating agency downgrades, and painful recapitalisations, and was now closing in on the half hour mark – a period of boom where investors would buy mining shares again.

“We moved the Investec Clock to 6 o’clock at the start of 2017 prompted by Sibanye’s bid for Stillwater, and Glencore’s recent attempt at outbidding Yancoal for Rio Tinto’s thermal coal operations reinforces our move,” said Investec in a note in mid-July.

However, it appears as if an advance to seven o’clock is not yet on the cards. “China has been the key buyer of mining assets, with Western companies unable to compete with China Inc given its lower cost of capital and apparent scant regard for ROIC [return on invested capital]. This may be coming to an end given the recent Chinese crackdown on capital outflows and overseas M&A affording Western companies the opportunity to win some of the tenders,” it said.

You wouldn’t call it merger and acquisition fever, but spirits are up; esprit is in the air.

“We believe Glencore is positioning itself for large mining merger and acquisition once again, and Rio [Tinto] would still be a desirable target,” said US investment firm, Jeffries, in a note in June, a reference to the events in 2014 when it emerged Glencore had explored the takeover of the Anglo-Australian firm.

We believe Glencore is positioning itself for large mining merger and acquisition once again – Jefferies

As for Glencore’s growth appetite, it does not appear to be a reversion to past activity where, with the slightest incentive from an improved commodity market, the world’s miners will embark on a new headlong dash into growth and capture of market share.

Parsimonious curatorship of the balance sheet remains important.

According to Moody’s analyst, Douglas Rowlings, liquidity has improved significantly among the high-yield mining companies this year. “Almost all companies display adequate to strong liquidity, a situation that contrasts with the past two years when 20% of the EMEA mining companies we rate had weak liquidity,” he said.

Glencore has reduced net funding and net debt over the past 18 months by $14.7bn and $14.1bn respectively to $32.6bn and $15.5bn. And in addition to its acquisition activity, it has conducted $3.2bn of asset sales in 2016 – a process it continued, albeit on a far smaller scale, in 2017 by selling its Rosh Pinah and Perkoa assets in Africa for $400m, and even disposing of Eland Platinum in the mother of all knock-down sales for some $13.4m.

Although miniscule in the Swiss group’s life, the Eland Platinum sale is instructive, however, of Glencore’s broader transactional strategy. The company also secured the marketing of Northam’s chrome production, a piece of negotiation that in a small way supports its marketing division, which has given it defensive qualities investors tend to prefer, especially as the effects of the commodity price correction are still fresh in the memories of investors.

Similarly, the Rosneft transaction represents an opportunity for Glencore to re-establish itself as a dominant trader of Russian oil after it was earlier usurped by rival Trafigura because it includes a new five-year supply deal with Rosneft for 220,000 barrels a day of crude.

In the estimation of EY global mining and metals transaction leader, Lee Downham, Glencore’s deal-making will become a broad reflection of other mining company activity in an effort to make sure “…you have the best assets in your arsenal”.

“This means rigorously and regularly evaluating each asset individually for how they sit within the portfolio and wider company strategy,” said Downham. “It may mean selling assets in the short term, or as the case may be, acquiring strong- performing, strategically aligned assets for future growth.”

In the case of Glencore, extracting marketing deals whilst selling and buying assets represents a shrewd turn in commerce since it assists the group’s marketing division, which is proven to support revenue in the down cycle.

THE Royal Bank of Canada (RBC) produced a report in May called Miningball , which evoked the spirit of Moneyball , the film about an American baseball team that used detailed statistics to improve performance in a way never seen before, and with unpredictably successful results.

RBC’s attempt was to “isolate the noise from individual company decisions”, which it achieved by aggregating large liquid mining company financials going back to 1994 and aggregating production into equivalent copper units. From this, it extrapolated a number of insights of which the most prominent was the following:

“We have created some statistics which we think should help investors with the wider investment decision for the mining space. In our view the data suggests that the sector is in a very compelling starting point with global long-term demand for metals likely to remain robust.”

For instance, it calculated current industry expansion relative to the industry’s total enterprise value – its market capitalisation and net debt – was at its lowest since 1994 while cash costs to million tonnes of copper equivalent had fallen to $6bn from $10bn in 2012, suggesting more cost compression was in the works.

If anything, analysis of this ilk reflects a more cautious approach to the metals and minerals market that was apparently absent during the hey-day of the super-cycle where rapid growth was applauded and abetted by shareholders.

Of the top 40 mining companies globally surveyed in PwC’s annual report Mine, approximately 50% of capital expenditure was related to sustaining activities. Of the $49bn in 2016 expenditure, only half was allocated to growing the business. As a further indication of health regained, impairment losses were also reduced last year.

“Although both indicators were below the prior year’s level, it is important to highlight that the proportion of impairments to capex (2016: 39%) has reduced to a level that is similar to 2012 (33%) from the peak of 2015 (77%), which indicates that miners are responding to messages around capital discipline,” said PwC in its report.

“I think we live now in world now that has an optimistic outlook for mining as capex is at record lows,” said Tim Clark, a senior analyst of Standard Bank Group Securities. “If you look across industry sectors, there is an absolute dearth of growth set against 3% to 4% demand growth so replacement [of metal supply] is going to have to come.

“The companies I deal with, the CEOs and the board, aren’t in the head space where they are going to turn on the taps again,” said Clark. “With R8.2bn in net cash, Kumba Iron Ore [the Anglo American listed subsidiary] decided not to declare a dividend. It has several years of capex in the bank with cash flowing in every day.

“It’s illustrative that management teams are not prepared to grow aggressively; they are still austerity managers. Those management teams have been through hell and the last thing investors want is over-optimism and hype. So we should move into a more balanced world of replacement investment, which will bode well for the industry going forward,” he said.

The companies I deal with, the CEOs and the board aren’t in the head space where they are going to turn on the taps again – Tim Clark

There is still scepticism, however, that the mining sector has not abandoned its old ways. Indiscipline will return as the sunnier souls in the sector exaggerate its potential. Said Piet Viljoen, executive chairman of asset management company, RECM: “The problem with mining is that it’s very cyclical and all its participants inevitably act pro-cyclically. They are always expanding when prices are high and bringing in supply at the wrong time.

“Then they are always contracting supply at the wrong time while the funders do the same. In the past, we regarded mining firms as growth companies, but successful firms are those that can resist the investment and banking community, and focus on the cost side.”

FROM a demand perspective, the turning point in the market was during the first quarter or 2016, according to PwC. Thereafter, metal prices have proved volatile, but company valuations are nonetheless starting to creep up again. The auditing firm now believes a level of stability has returned to the market.

But it’s impossible to speak in general terms about the commodity class where there is divergence between individual metals. According to Ben Jones, a principal consultant at CRU Group in the UK, a recent survey of the firm’s clients found that there was most demand optimism for so-called “sexy tech” metals such as lithium and cobalt.

“We expect that the key input materials for batteries in electric vehicles, for example, will grow very significantly in the years to come. More generally, our feeling is that the outlook for base metals is more optimistic than everyone else, more than for iron ore or coal.

“But again, the devil is in the detail so even within commodity classes, we’re seeing quite divergent demand patterns. Take potash and phosphates – two key fertiliser compounds – but our view is that potash is expected to perform better in years to come,” he said.

This was echoed by both the large and the small in the mining world. For instance, the small- to mid-cap chrome and platinum group metal (PGM) producer, Tharisa, which is listed on the Johannesburg Stock Exchange, noticed a sea-change in the world of mining.

Commenting on the chrome price, which showed enormous volatility by more than doubling in value in 2016 before falling back again, Tharisa CEO, Phoevos Pouroulis, said that the market had bottomed out. “The fundamentals of the global stainless steel market remain sound with continued growth forecast in 2017, further supporting strong demand for chrome units in the form of ferrochrome and chrome ores,” he commented in July.

Said PwC: “While spot commodity prices remain volatile, long-term analyst consensus price forecasts held relatively stable throughout 2016. The key to a sustained recovery will be to ensure that the industry does not repeat the mistakes of the last boom cycle: buying high, pumping up production with marginally profitable and expensive projects, and then recording significant impairments when commodity prices decline.”

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