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Top mining, metals companies warned not to take debt reduction too far

15th June 2017

By: Esmarie Iannucci

Creamer Media Senior Deputy Editor: Australasia

     

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PERTH (miningweekly.com) – New research from advisory firm Ernst & Young (EY) has shown that global mining and metals companies are in danger of going too far in their efforts to reduce debt and could compromise their long-term growth opportunities.

In a new report, EY noted that debt has fallen by almost 25% in the sector from peak levels in 2014 following the end of the supercycle, with the majority of debt reduction happening in 2016.

The report, analysing the top 50 mining companies in the world by market capitalisation, revealed that, in 2016 alone, debt fell by 17%, or around $39-billion year-on-year, and identified proceeds from asset sales, curtailed capital spending and suspended dividends as contributing factors to reduced debt.

Bulk producers and the diversified miners accounted for the majority of the overall reduction in net debt in 2016. Buoyed by steep rises in coal and iron-ore prices, bulk product miners prioritised strengthening of balance sheets in order to position themselves against future price volatility, the EY report found.

“A relentless focus on cash optimisation through cost cutting and productivity improvements over the last few years, in addition to a recovery in commodity prices, has led to remarkably low debt in the mining and metals sector,” said EY global mining & metals transaction leader Lee Downham.

“Companies have increasingly shifted capital structures to equity, increasing flexibility but resulting in higher overall cost of capital.

“Restoring dividends and implementing capital return programmes to shareholders is indicative of a cautious mindset across the sector and one that could hinder growth ambitions and, ultimately, companies’ abilities to generate attractive returns.”

Downham pointed out that gearing dropped to 34% among the top 50 miners in 2016.

In its report, EY warned that should the sector continue to pay down debt at the same rate, net debt would fall by around 20% in 2017.

Downham said this kind of further reduction in debt will result in less efficient capital structures among companies and further question their ability to generate returns, which are already relatively lower than other sectors.

“Companies face the very real risk of letting debt levels fall to lows that create inefficient balance sheets and overlooking necessary investment in projects to generate returns down the road. The cautious mindset that has helped many companies weather volatility over the last few year could now become their biggest obstacle to future growth.”

He noted that reduced growth ambition is translating into lukewarm transaction activity in the sector, with momentum remaining subdued as participants continue to be cautious about global demand growth and ongoing volatility.

Deal volume in the first quarter of 2017 grew minimally by 6.5% over the same period in 2016 and fell by 18% quarter-on-quarter.

“Exploration spend has deteriorated in recent years and project pipelines remain challenged. We expect companies to increasingly look to make the difficult call on which portfolio to choose to back investment, as many realize perfect investment conditions may never materialise,” Downham said.

Edited by Chanel de Bruyn
Creamer Media Senior Deputy Editor Online

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