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After 2017 consolidation, mining to pre-empt future metals demand – EY

Photo by Bloomberg

JOHANNESBURG (miningweekly.com) – With stronger balance sheets across the mining and metals sector, miners are increasingly returning to an investment-led strategy, which is driving a renewed focus on building portfolios that deliver sustainable shareholder returns, says multinational consultancy Ernst & Young (EY).

The focus shifts from debt reduction to creating shareholder value. Increasing productivity as demand for metals improves will mean more working capital requirements for many companies, while others may refinance high-cost facilities.

The sector is returning to growth, but mining and metals companies face a transformed competitive and operating landscape, EY’s ‘Mergers, acquisitions and capital raising in mining and metals – 2018 outlook’ report, which was published on Tuesday, stated.

The need to improve shareholder returns will drive strategies to accelerate productivity, improve margins and better allocate capital to achieve long-term growth. Digital innovation will be a key enabler, but the industry must overcome a poor record of technology implementations.

“If mining and metals companies are to survive and thrive in a new energy world, they must embrace digital to optimise productivity from market to mine.

“The key investment drivers are pipeline replenishment, synergistic volume growth and next-generation mineral demand. With the rise in demand for electric vehicles (EVs) and battery storage, portfolios are beginning to shape themselves towards new technologies. Companies with an eye on growth should start to consider how these minerals could fit into their portfolios,” said EY Global Mining and Metals Transactions lead partner Lee Downham.

Lithium and cobalt assets across the world have seen increased interest from diversified miners, niche players and financial investors.

“Key metals in the batteries powering EVs are cobalt, lithium and nickel. Supply of these metals is not expected to meet forecast demand.”

Cobalt faces significant supply challenges owing to the location of mineral deposits and the limited number of new mines coming online. Cobalt supply is heavily reliant on the Democratic Republic of Congo (DRC), which currently produces 65% of global supply and holds almost half of the world’s reserves.

However, political instability in the DRC and the challenge of ethically sourcing cobalt have made it a less attractive but still necessary investment region.

The supply of lithium is not as constrained. Future pricing will be quality-led and likely to go through demand cycles. However, there is increased interest from car manufacturers in investing in mines to source materials for their EVs.

“The focus remains on the quality of assets and 2018 will likely see a handful of larger transactions in anticipation of greater competition for the commodities of the future. The quality of assets will be a key consideration in executing a growth agenda.

“In 2018, we expect to see more deals supported by investment-led strategies to diversify by commodity or region. Some of this activity will be to shape portfolios for future growth and sustain shareholder returns,” said Downham.

EXPLORATION AND DEVELOPMENT
Conversely, the quality of projects at the exploration stage continues to erode and the allocation of financing for new exploration mandates has been limited.

“Junior players with proven resources ready for development will be of interest to both producers and financial investors. However, the reduced inventory of exploration and development stage projects may limit investors to buying producing assets to increase output volumes.”

Nevertheless, the return to growth and an appetite to fund development projects are expected to be the key drivers for secondary listings this year. Commodity prices have risen significantly since 2016, and equity valuations have appreciated accordingly.

There was renewed activity for exploration stage assets with deals increasing significantly to 31 deals totalling $72-million in 2017. Roughly 75% of the deals targeted assets in low-risk jurisdictions, such as North America and Australia, with prospects generally focused on exploring for precious metals.

“Stronger financial health has also enhanced options in accessing financing for growth through consolidated and strategic transactions. The healthy outlook for the mining and metals sector boosted access to debt and improved the ease of raising finances via equity markets.”

The ease of securing funding for the growth agenda has improved. Financing options are not limited to traditional sources and innovative financing solutions are being structured to address newer risks posed by investments in lithium and cobalt.

“Key to competitiveness and sustainable value creation will be achieving the right mix of capital, which balances near- and long-term liquidity with flexibility and at an optimal cost,” the EY report advised.

The expected return on investment across the sector will be the major driver of new bond issuance in the near term. The case for issuing new notes will be supported by the significant deleveraging that has taken place in recent years, arguably resulting in capital structures that are too equity heavy. Further, investor demand for bonds has improved due to better credit ratings.

“Access to capital improved significantly in 2017. In 2018, we expect stronger demand for financing and for flexibility to remain important, as the sector seeks to maintain a balanced and efficient capital structure,” said EY Global Mining and Metals Transactions senior strategic analyst Hopewell Mauwa.

“Debt-to-equity ratios for most players have fallen below 30%, raising questions on the efficiency of capital structures and, in turn, raising the likelihood of further share buyback programmes.

“However, returning cash alone will not be sufficient to provide sustainable value creation. Mining and metals companies will look to growth either through investing in pipeline projects or through [the] acquisition of other assets, provided they complement existing portfolios. While past experiences may cap the appetite for new debt, inefficient capital structures will support moderate expansion of debt financing in 2018.”

The focus for most of the mining and metals sector in 2017 was consolidating balance sheet strength, improving financial resilience and maintaining capital discipline.

“With metals prices stable and, in certain cases, rallying through the year, cash generation remained strong across the sector, allowing leverage to be reduced, dividends restored and cash returned to shareholders,” EY said in the report.

Mining and metals equities were attractive to investors in 2017 owing to decreasing financial risk mainly achieved through debt reduction. The sector’s net debt declined by at least 15% in 2017, according to EY estimations.

LARGER DEALS
There was a significant increase in deal value across the mining and metals sector in 2017, marking the highest value of completed deals since 2013.

“Deal value rose by 15% year-on-year to $51-billion as deal drivers shifted from divestment-led to strategically focused, but the volume of transactions fell by 6% year-on-year.

Coal and steel were the main drivers of deal value, with coal acquisitions up 156% on 2016 to $8.5-billion, while volumes fell by 27%. This, in part, reflects several thermal coal divestments from the large, listed producers looking to reduce exposure as the energy mix moves toward renewables.

Steel transactions doubled in value to $13.3-billion, the bulk of which, ($9.3-billion) comprised the large Chinese mergers and divestments in Latin America, such as Thyssenkrupp’s disposal of its Brazilian steel mill to Ternium.

Gold deals declined in 2017, falling 34% by value to $7.3-billion.

Deals in lithium, copper and cobalt are expected to feature high on the agenda of management teams across the industry going forward.

Continued pressure to reduce the reliance on fossil fuels will also lead to further divestments or spin-offs.