London — When Anglo American CE addressed analysts and investors on a recent trip to SA he had a simple message: the FTSE 100 miner was prepared to hold on to assets previously deemed noncore and run them for cash — unless it received the "right" price from buyers.
Those comments marked a sharp shift from January when Anglo, under attack from hedge funds, put a bundle of assets up for sale as part of a radical "shrink to survive" strategy.
Since then the mining sector has enjoyed a dramatic change in fortunes as a sharp and unexpected rebound in commodity prices such iron ore and coal has boosted profits to such an extent that large diversified miners such as Anglo and Glencore will comfortably achieve debt reduction targets.
The question now facing an industry that acquired a reputation for profligate spending and dealmaking during the 2004-2011 commodities boom is how they deploy this cash windfall generated by the bounce-back in prices.
Their choices will help to determine the direction of share prices next year and whether 2017 will be a bumper year for shareholder returns.
"Management teams have gone through a particularly horrible time and have learnt their lesson," says Barings Asset Management fund manager Clive Burstow. "There is a lot of producer discipline and that’s key to this becoming a more sustainable cycle."
From a 12-year low in January, the FTSE all share mining index has doubled in value and is among the best-performing sectors in Europe. Anglo American and Glencore — two of its largest constituents — are among the best performers, up 310% and 220%, respectively.
The rally started in the spring after policy makers in Beijing turned on the credit taps to support economic growth. Later they ordered production curbs to boost the profitability of China’s heavily indebted coal mining industry.
In spite of this year’s recovery, many analysts and investors believe the re-rating of mining stocks has further to go. "We are at the start of an upcycle that will gather further steam," says Neil Gregson, natural resources portfolio manager at JPMorgan Asset Management. "Demand is OK and the industry is working through excess supplies."
Certainly, there are few signs that miners are about to sink billions of dollars into new projects just because prices have rallied. The executives at the top of the world’s biggest mining groups continue to trim capital expenditure and put profits above chasing market share.
Any spare cash they generate is likely to be returned to shareholders through dividends, which were cut or suspended over the past 18 months.
Glencore, which suspended dividends in September 2015, has just announced plans to pay shareholders at least $1bn in 2017 and announced a dividend policy linking payments to its ability to generate cash. Vale, the world’s biggest iron ore miner, is also restarting payments "After a decade or so of the mining industry defending its dysfunctional behaviour we think there are enough signs that there is an alteration in behaviour," says Citi analyst Heath Jansen.
In his first detailed strategy presentation Rio Tinto CE Jean-Sébastien Jacques said he was focused on sweating the group’s assets harder rather than pursuing ambitious deals and bold projects in far-flung parts of the world.
After several years of cutting costs, Jacques believes the Anglo-Australian miner can still boost its cash generation by as much as $5bn by 2021 by grappling with seemingly mundane issues, such as running its vast haul trucks for longer.
"Shareholders will have a machine that will generate a lot of cash," says Jacques, adding that Rio will only pursue acquisitions if there is a clear case. "There’s lots of speculation about copper and we can grow copper and so on and so forth. We love copper but we are not going to pursue an acquisition in copper for the sake of it," he says.
As well as productivity, miners are also focused on strengthening their balance sheets. Jacques and Cutifani say a more conservative balance sheet is needed because they expect market volatility while China’s economy matures.
Glencore has a different reason for seeking to strengthen its finances. Shares in the miner-cum-commodity trader plummeted last year under a fierce attack from hedge funds who saw the company as the easiest way to make money from falling commodity prices.
Glencore chief Ivan Glasenberg now wants to make sure this can never happen again. He told investors at a recent strategy briefing that the company’s priority was securing a higher credit rating and making sure its ratio of net debt to underlying earnings never rose above two.
"We don’t want to be left in that precarious position where the market can hammer us because they have a different outlook on commodity prices," he says.
After cutting net debt from $26bn in January to about $17bn, Glencore expects to end the year with a ratio of 1.8.
"From an equity point of view we are in the sweet spot where companies are keeping their foot firmly on the cost control pedal in a better commodity price environment. The extra revenue from higher prices is going to flow straight through to the bottom line," says Gregson.
He adds it will be a while before the industry as a whole starts to think about development pipelines and significant new capacity, although BHP Billiton has agreed two deepwater oil and gas investments.
"We are a good few years away from that, if not longer," he says.
While the mantras of cost control and caution look set to remain, the performance of the mining sector will be mainly driven by commodity prices and therefore China, the world’s biggest consumer of raw materials. And on this front there are reasons to be cautious.
The commodities rebound has been driven to a large extent by policy changes in China that could be reversed. High-cost capacity that was mothballed by small producers during the downturn could also come back online.
"We see many of the catalysts driving miners at present as eventually fading," says Andrew Keen at China’s Haitong Research. "We think recent strength is an opportunity to take profits."
But the prevailing view among traders and mining executives is that Chinese demand will hold firm because 2017 is a big year of political transition and Beijing wants to keep the economy on track. At the same time, an uncertain outlook for prices will keep supplies from returning to the market.
"We feel very confident on the demand for our commodities, for cobalt, for nickel, for zinc, for thermal coal," Glasenberg said in December. "New supply is very limited."
Post-boom Barrick aims for flat production
Barrick Gold, the world’s largest gold miner, is a symbol of the precious metal industry’s fortunes.
The Canadian group’s market capitalisation surged to more than $56bn in 2011 as gold prices rose to record levels of $1,900/oz. It has since fallen back to $18.5bn as it focuses on cutting debt and improving operational efficiency.
It is aiming for production to remain roughly flat to the end of the decade.
Barrick wants to focus on core operations in Latin America and cut costs there. It also aims to reduce net debt by more than $2bn this year and achieve a cash-cost of less than $700/oz by 2019.
Like other miners, Barrick is heavily leveraged to the gold price, which has fallen 8% since the US election of Donald Trump as investors move to equities and industrial commodities.
In November $4.5bn flowed out of exchange traded funds (ETFs) backed by the precious metal, according to BlackRock.
© The Financial Times 2016