MINING AND MINERALS

MINING & MINERALS 07

Introduction

Three main categories of the mining industry are precious metals and gemstones, industrial and base metal mining and nonmetal mining

The mining industry consists of junior miners, which are smaller companies engaged in the exploration of new mining deposits, and major mining companies such as Rio Tinto (RIO) and BHP Billiton (BHP)

Many junior mining companies that make large discoveries are eventually acquired by a major mining company that has a large portfolio of claims and thus able to finance large-scale mining operations.

Compared to major mining companies, junior mining companies are usually riskier ventures and are subjected to more volatility.

Overall, high barriers of entry exist in the form of high capital requirements, rights to develop a resource, regulations, natural economies of scale and capacity to market commodities to major export markets.

1)GLOBAL COMMODITY PRICES

World Price of Iron Ore

Mining companies are reliant on iron ore sales, meaning that iron ore prices exert a significant influence on the viability and profitability of the mining industry. Indeed, as iron ore prices increase, revenue will also increase. Although recent global iron ore prices have fluctuated with a general upward trend, the world price of iron is projected to decline in 2019-20.

World price of steaming coal

As black coal mining is one key activity within the industry, the world price of steaming coal drives the industry’s performance. As steaming coal price increase, this increases industry revenue. The world price of steaming coal is projected to decrease in 2019-20.

World price of natural gas

The revenue for the mining industry is largely contributed by sales from natural gas. As the extracted volume of natural gas increases, this supply increase results in natural gas prices increasing. If natural gas prices decrease, this can reduce revenue, hindering industry growth. The world price of natural gas is anticipated to decrease in 2019-20. However, Provided that a mine is fully operating, an increase in the market price of a material generally does not increase a mining company’s production costs. These increased market prices contribute directly towards the mining company's bottom line net profits. As the market price of materials increase, the company share prices often also increase exponentially.

2)CAPITAL INVESTMENT

Mining is an industry which requires capital expenditure through investments in mining and energy projects for purposes such as infrastructure. This means that as capital expenditure increases, revenue and growth also increase. In 2019-20, actual capital expenditure in mining was projected to increase.

3) EXCHANGE RATES

US dollars per Australian dollar

Usually, prices of mining industry commodities and products are recorded in US dollars. Hence the exchange rate influences the amount of AUD revenue earned by local producers. If the Australian dollar is weaker, prices become more competitive, positively affecting domestic miners. The Australian dollar is expected to depreciate against the US dollar in 2019-20.

4)GROWTH OF EMERGING ECONOMIES

GDP of mainland China

As the industry heavily relies on exports, the economic growth of Australia’s major trading partners, especially countries like China, and Japan, is a key factor which influences the industry’s growth. Downturn in China’s GDP growth adversely impacts the mining industry, considering how they are Australia’s largest trading partner. As the Chinese demand for materials decreases, this threatens future mining projects by companies

5)OPERATIONAL COST EFFICIENCY

Operational cost efficiency is intrinsic for a mining company to remain profitable. As large capital expenditures are required by mining companies to set up mines, this process demands meticulous planning and careful cost management.

RISKS

Mining companies face political, geological and price risks.

Generally, companies prefer working in countries with stable political systems as otherwise, sudden changes in the political environment such as nationalisation can drastically alter the regulatory conditions which affect the company’s mining claims and ownership of foreign property.

As most of the oil and gas wells have either already been or are in the process of being tapped out, there is also an inherent geological risk in finding lucrative locations to stake claims. This difficulty in mining extraction means it is also possible to yield less amounts of material compared to what was estimated. Although this risk is applicable to both major and junior companies, having some deposits come up empty is more financially devastating to a junior due to their smaller portfolio of claims and lack of a capital cushion to fund further exploration. Furthermore, companies are exposed to price risk, where fluctuations in the prices of commodities can result in lower profits or financial losses. Investing in junior mining companies is ideal for risk capital, as they have the potential for a lot of appreciation. Major mining stocks however, are comparatively lower-risk and more stable while still offering decent appreciation

According to KPMG’s Australian Mining Risk Forecast 2019/2020, specific risks that are most prominent risks within the Australian mining industry include:

1)Stakeholder expectations

Society, and therefore stakeholders, have grown to have greater expectations for companies to act ethically. If a mining company ignores these ideals, such as the developing anti-coal sentiment hindering Australian mines’ ability to 2)Ability to maintain create new coal mines, their productivity and control operating costs company’s reputation could be While operating costs will naturally grow over seriously impacted. time, mining companies need to compensate for this by cutting costs or making other processes more efficient. Companies must be careful in doing this with the risk of significantly depleting productivity in exchange for reduced costs. Exploration is essential for future growth and stability of the industry to replace mining reserves that are rapidly depleting. As more reserves are exhausted, mineral quality and availability in domestic locations will eventually reduce, which may lead to some Australian centred organisations to commence activities in foreign jurisdictions for the first time, Venturing out of familiar jurisdictions may expose some organisations to new 3)Access to key talent Recent low numbers of enrolments risks, especially political and social, driven by the jurisdiction they are operating in. in mining engineering courses pose a risk to the important task of acquiring talent and retaining them for future roles within the sector. To address the risk, companies may need to rely on “digital” talent as an avenue to ensure that companies can carry out the vital control and maintenance for their technologies and data analysis.

Several key ratios exist when analysing mining stocks:

Quick ratio

Measures a company’s liquidity and financial solvency how well a company is able to deal with its current short-term financial obligations with liquid assets (assets that can be quickly converted into cash) Calculated by dividing the total current assets minus inventory by the company's total short-term obligations Often referred to as the "acid test ratio" because it is considered such a strong fundamental indicator of a company's basic financial health or soundness Important for evaluating mining companies because of the substantial capital expenditures and financing necessary for mining operations. Analysts and creditors prefer to see quick ratio values higher than 1, which is the minimum acceptable value

Operating profit margin

Strong indicator of the company’s future growth and revenue As a primary profitability ratio, analysts use this to determine the effectiveness of companies in managing their costs Calculated by dividing total revenue by total company expenses, excluding taxes and interest Important because mining companies often have to adjust their production levels, which requires significant changes in their total operational costs

Return on equity (ROE)

Shows the profit levels a company can generate from equity and return to stockholders The average ROEs in the mining industry ranges between 5% and 9%, with better performing companies producing ROEs closer to 15% or more Calculated by dividing net income by stockholder’s equity The return on common equity ratio (ROCE) results from the exclusion of preferred stock equity and preferred stock dividends in these calculations

CASE STUDY

BHP Group Limited (BHP), formerly known as BHP Billiton Ltd, is an Australian company engaged in the exploration, processing and production of mineral and energy resources, its revenue predominantly sourced from its iron ore and coal. With a current market capitalisation of approximately $101B, BHP is the third largest company in Australia and falls within the ASX 200 GICS Materials sector.

P/E Ratio = 14.27 EPS = 1.87

Australian iron ore accounted for 38.5% of company revenue in 2018-19. This percentage is expected to remain largely stable in the current year, as the company continues to derive a high proportion of revenue from their iron ore, oil and gas projects. BHP is anticipated to derive approximately 70% of its total revenue from its Australian operations in 2019-20.

It would not be recommended to invest heavily in the Materials sector, which has been adversely affected by the COVID-19 social distancing regulations that have restricted the amount of work that can be completed.

CONCLUSION

The mining industry is expected to increasingly focus on their output and productivity over the next five years As the COVID-19 pandemic eventually stops, global economic conditions are projected to remain stable over the next five years, increasing the demand of resources globally

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