Build, buy or return: what will global miners do with their cash?

THE unexpected upturn in commodity prices this year has provided a “short-term window of opportunity of about six to nine months” to the global mining groups, but it was too soon to predict how this would affect management strategies.

That’s according to Colin Hamilton, head of global commodities research at financial institution Macquarie. who was taking part in a presentation on the global commodity markets ahead of the London Metals Exchange week which kicks off in London on October 31.

According to the Macquarie analysts the jump in commodity prices – which has been triggered by an unexpected surge in demand from China – combined with the ‘self help’ measures taken by the mining groups to cut capital expenditure and operating costs had greatly boosted their free cash flows.

These improved financial circumstances had taken the pressure off some of the mining groups to sell assets they had previously indicated were non-core and would be disposed.

Alon Olsha, senior metals and mining analyst, commented: “Glencore, Anglo American and Vale seem to have slowed down their asset sales programmes because of their better cash flows. They seem to be holding out for higher prices or are struggling to finalise valuations because commodity prices keep moving upwards.”

He singled out Anglo American’s proposed sale of its Australian metallurgical coal assets as a case in point. “That’s taking a very long time to complete probably because of the doubling of the price of coking coal over the past year while some observers are suggesting perhaps the assets should not be sold at all.

“That’s not Macquarie’s view because we do not believe the underlying fundamentals have changed and there’s also the issue of Anglo’s management credibility which will be helped if they get that sale away.

“We currently think those assets could be sold for $1.5bn but that figure could be pushed to $2bn,” Olsha commented
Macquarie’s assessment was that Glencore had so far done the most in terms of ‘self help’ while Brazilian resource giant Vale had done the least and Anglo American was “somewhere in the middle.”

Olsha commented: “Vale is the one company that has really lagged. We are waiting for the Moatize deal to be finalized because that could bring in some $3bn for them.”

According to Macquarie’s overall assessment, the investment debate had changed from one of capital cuts to one of capital deployment in that the mining groups had largely convinced the markets they were no longer in a position of short-term risk in terms of their balance sheets.

Turning to management strategy, Olsha reckoned the mining groups faced choosing between policies that could be summed up as “build, buy or return cash” in terms of their rising cash balances.

He noted some increased activity in merger and acquisition activity but generally ruled out decisions to invest in new capacity because of continued concerns over the sustainability of the price increases.

“The six to nine months window of opportunity is too short to influence investment decisions on new capacity so we think that’s unlikely to happen,” he said.

That left management teams facing a decision on whether to return cash to shareholders – through special dividends or share buybacks – or to hoard it. Olsha’s assessment was that: “… we don’t think that the companies feel confident enough to start returning cash to shareholders in a meaningful way”.

Turning to specific commodities, the Macquarie analysts were bullish on prospects for zinc, nickel and chrome over the next year. They were more cautious on coal and copper.

Hamilton said the export thermal coal price had jumped this year because of cutbacks in Chinese production, but he noted the Chinese government kept a close watch on energy costs and was likely to restart some of its mothballed domestic production.

His prediction was that export coal prices could pull back to around $60/tonne FOB (free on board) Richards Bay and Newcastle. The current Richards Bay FOB price is around $70/tonne.

Regarding copper Macquarie senior commodities analyst, Vivienne Lloyd, believed additional supply – particularly from Peru – would keep the copper price stuck in a range from around $4,000/t to around $5,000/t “for the next two to three years”.