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©2014 GERSON LEHRMAN GROUP, INC. ALL RIGHTS RESERVED.
Neal Brewster Elemental Economics www.elementaleconomics.com
JANUARY 19th, 2016
MINING VALUATIONS & INDUSTRY OUTLOOK
©2014 GERSON LEHRMAN GROUP, INC. ALL RIGHTS RESERVED.
Neal Brewster Neal Brewster is a consultant providing economic and valuation advice to investors in the natural resources sector.
He was previously Group Practice Leader and General Manager of Valuation for Rio Tinto where he was responsible for developing and applying valuation methodologies across Rio Tinto globally, including new capital investments, existing operating assets, M&A opportunities and divestments. Neal was responsible for establishing Rio Tinto's valuation guidelines and protocols, setting Group discount rates, assessing country risk and advising on investment decisions and strategy. Neal spent 3 months as acting Head of Global Business Evaluation.
Between 2006-2010, Neal was the General Manager of Forecasting for Rio Tinto were he led Rio Tinto's macroeconomic and commodity price forecasting (covering industrial metals from aluminium to zircon as well as energy products) and provided key guidance and support on economic and market issues to Group planning and strategy.
From 2004-2006, Neal was the Manager of Industry Analysis for Rio Tinto's steel and iron ore sector. This included leading country studies on China and India to determine the outlook for steel and iron ore markets. From 1997-2004, Neal was an economist for Rio Tinto and carried out multiple analyses on various commodity and industry issues.
From 1991-1997, Neal was an Economic Advisor for the UK Ministry of Agriculture.
Agenda
• Outlook for the mining sector and the changing industry context
• Shifts in the mining cost curve and implications for prices
• Discrepancy between what valuation models are saying and how mining stocks are trading
• Miners’ response to the downturn and ability to access financing in 2016
Metals markets were the worst performing global asset class in 2015
Selected Asset Returns in 2015
Source: Elemental Economics, IMF, Quandl
70
80
90
100
110
120
130
Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15
IMF energy price index
IMF metals price index
US residential house price index
Global government bond market
Global equity market
Metals prices have halved over the last four years and some major mining equities fallen by over fourth-fifths
-100% -80% -60% -40% -20% 0%
Lead Silver Gold
Thermal coal Aluminium
Met coal Tin
Copper Zinc
Platinium Palladium Oil (WTI)
Steel Nickel
Gas (US) Iron ore
Commodity Prices
Changes in Commodity Prices and Mining Equities in 2015 and Against 5-year peak
-100% -80% -60% -40% -20% 0% 20%
Euro AUD CHP CAD SAR BRL
Newmont S&P500
FTSE100 Barrick
Rio Tinto BHPB (ADR) Vale (XNYS)
Freeport Glencore
Anglo American
Mining Equities and Exchange Rates
Change in 2015 (to 24 December)
Cumulative change from 5-year peak Source: Elemental Economics, Quandl, Yahoo, IndexMundi,
Despite four years of decline many metals prices remain above pre-2005 levels
0
1000
2000
3000
4000
5000
6000
7000
8000
9000
10000
1930 1940 1950 1960 1970 1980 1990 2000 2010
Spot price (14/1/16)
Copper Price (2015$ per tonne)
Source: Elemental Economics, Quandl, LME, US Census Bureau
The immediate cause of the price collapse is slowing Chinese demand for raw materials
Source: Elemental Economics, WBMS
0%
5%
10%
15%
20%
25%
30%
00 02 04 06 08 10 12 14 0
5
10
15
20
25
00 02 04 06 08 10 12 14
Thou
sand
s
World China
Growth in Chinese Industrial Production and Copper Demand (Percent yoy)
World Copper Demand (Million tonnes a year)
Industrial production Copper demand
This is partly cyclical but per capita Chinese metals consumption is now around western levels
0
5
10
15
20
25
0 10000 20000 30000 40000 50000 60000
Copper consumption (kg/capita)
GDP/capita ($ at PPP exchange rate)
Per Capita Copper Consumption and incomes
Source: Elemental Economics, IMF, WBMS
China 2015
China 2005
China 2010 USA
Germany South Korea
Taiwan
Japan
Russia Brazil
Note: Size of bubble indicates relative level of consumption
This has coincided with an acceleration in capacity as previous investment has hit the market
0
20
40
60
80
100
120
140
160
180
200
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Impact of GFC was to curtail investment and
“supercharge” subsequent price rises
Slow initial response to rise
in climbing commodity prices
Investment bubble occurs as prices reach
multi-decade highs
Investment bust
Asia crisis and early 2000’s downturn results in lower
capital spending and reduced industry capacity
Source: Elemental Economics, PwC
Mining Sector Capex ($2015 billion)
The industry is achieving significant operating cost reductions in response to lower prices
• Depreciation of local currencies
• Lower oil prices
• Lower sea freight rates
• Governments assistance
• Productivity and other cost improvements
• Increase scale of production
0
5
10
15
20
25
30
2011 2012 2013 2014 2015/latest
Rio Tinto Vale
Iron Ore Cash Costs ($/dwt)(1)
Source: Elemental Economics, Company Data (1) FOB costs excluding royalties and sustaining capital
Despite these cost reductions significant portions of the industry are current running at operating losses
-45%
-40%
-35%
-30%
-25%
-20%
-15%
-10%
-5%
0%
Copper Aluminium Seaborne iron ore
Spot Price Margin Over 9th Decile Industry Costs
0%
10%
20%
30%
40%
50%
Copper Seaborne iron ore
Aluminium
Proportion of Supply Operating at a Loss
Source: Elemental Economics, snl, Alcoa
Some cutbacks have taken place but there is a tendency for supply to be sticky for extended periods
• Fragmented markets and absence of industry leadership • Sunk capital costs do not impact current operation decisions • Significant scope to make cost reductions • Closure-restart costs can be significant • Short term operating decisions are usually based on variable costs
excluding fixed costs and take-or-pay contract input costs • Expectation of price rebound • Tendency to high grade in response to lower prices • Constrained ability to lay off staff and fear of social impacts of closure • Government support • State ownership • Able to export or sell to stocks • Low interest rates and “zombie” producers
1400
1500
1600
1700
1800
1900
2000
2100
2200
2014Q1 2015Q1 2016Q1 2017Q1 Long run
Consensus view is for a slow reversion in commodity prices to more sustainable long run levels
Aluminium Price ($ per tonne) Copper Price ($ per tonne) Iron Ore Price ($ per tonne)
0
20
40
60
80
100
120
140
2014Q1 2015Q1 2016Q1 2017Q1 Long run
4000
4500
5000
5500
6000
6500
7000
7500
2014Q1 2015Q1 2016Q1 2017Q1 Long run
Source: Elemental Economics, IMF, Rio Tinto
* * *
Note: Long run prices based on the incentive price of new installed capacity at Q2 operating cost levels. Iron ore price is CFR China for 62% Fe ore
Bank analysts IMF
Cash generated in the mining boom was disproportionally invested rather than returned to shareholders
-50
0
50
100
150
200
250 2015$ Billion
Net borrowing from
bondholders
Note: Balance reflects cash and other changes
Investments Payments to shareholders
Source: Elemental Economics, Company reports
-50
0
50
100
150
200
250
2015$ Billion
Distribution of Rio Tinto Cash Flow 2005-14 Distribution of BHP Billiton Cash Flow 2005-14
Net borrowing from
bondholders
Investments Payments to shareholders
The prior boom in commodity prices masked an underlying poor rate of return by the mining industry
0
5
10
15
20
25
1975 1985 1995 2005 2015
Source: Elemental Economics, CRU, E&Y
Mining Sector ROCE (Percent)
Disillusion by investors and funding concerns is resulting in discounted market equity valuations
Share price
Market cap ($b)
EV ($b)
D/E Dividend yield
EBITDA ($b) EPS ($) EV/EBITDA P/E 2015 2016 2017 2015 2016 2017 2015 2016 2017 2015 2016 2017
Rio Tinto £16.71 45.1 60.5 0.34 9.20% 12.6 11.1 12.8 2.0 1.9 2.5 4.8 5.5 4.7 12.0 12.6 9.6
Anglo American £2.33 4.7 17.6 2.75 10.9%(1) 4.8 3.9 5.1 -2.7 0.3 0.9 3.6 4.5 3.4 -1.3 10.2 3.9
BHP Billiton(3) £6.23 52.0 78.4 0.51 11.50% 12.7 14.8 18.7 0.5 0.7 1.1 6.2 5.3 4.2 20.1 13.3 8.2
Glencore £0.70 14.9 46.8 2.13 7.8%(1) 8.6 8.3 9.7 0.0 0.1 0.1 5.4 5.7 4.8 51.0 12.7 7.8
Vale $1.74 10.8 38.0 2.52 16.3%(2) 7.1 7.1 10.2 -0.8 -0.2 0.4 5.3 5.3 3.7 -2.3 -10.2 4.4
Median 5.3 5.3 4.2 12.0 12.6 7.8 Mean 5.1 5.3 4.2 15.9 7.7 6.8 Valuations as of 14/1/2016 (1) Based on previous dividend rate. Dividends suspended for 2H2015 and 2016 (2) Under review (3) Financial year, ending June the following year
0
20
40
60
80
100
120
140
Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16
Local Share Price Index (1/1/15=100)
Rio Tinto
BHP
AA
VALE.P
GLEN
Source: Elemental Economics, 4-traders.com, Quandal
Mining companies are responding in a number of ways to strengthen balance sheets and to restructure themselves
BHP Billiton Rio Tinto Glencore Anglo American
Costs $4.1b cost saving in 2015
$1b cost saving in 2015
$0.4b cost saving in 2015
$3.7bn reduction targeted 2013-17 and
85k job loses
Production No No
500kt reduction in zinc, 100kt reduction in lead and 455kt reduction in copper production in
2016
Diamond production in 2016 26-28m.ct from
31m.ct in 2014
Capital spending
2014: $9.1b 2016: $5.2b
(Note: mining capital only)
2014: $8.2b 2016: $5b
2014: $8.3b 2016: $3.8b
2014: $6.1b 2016: $4b
2017: $2.5b
Equity raising No No $2.5bn equity raising No
Dividends No change yet No change yet Suspended Suspended and move to payout ratio
Divestments Divestment of South32
Lonmin stake divested. Cobar, Lomas Bayas
and agricultural interests put up for sale.
Non-core Chilean copper assets
Other
Focus on reducing working capital.
Project financing of Oyu Tolgio underground
$900m silver streaming deal with
Silver Wheaton
Source: Elemental Economics, Company reports
Conclusions
• Witnessing an unprecedented collapse in commodity prices driven by a structural change in Chinese growth coinciding with the impact of a period of previous excess investment
• Current industry margins are unsustainable but stickiness in supply means this can persist for an extended period of time and the market adjustment will come through cost falls as as well as, eventually, higher prices
• Investors seem to have “given up” on the mining sector and this is resulting in depressed valuations which discount the likelihood of any recovery in margins taking place in the foreseeable future
• Mining companies are responding aggressively in terms of costs and capital plans and changes in the way in which the industry is financed and future income is redistributed are occurring. Depressed valuations are resulting in significant interest from new investors although little actual activity is taking place – could we see an M&A frenzy as distressed sellers finally capitulate?
• Prices can “whiplash” when supply-demand balances tighten. Gauging the timing of this eventual upturn is the critical issue to successfully investing in mining.
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