Industry Trend Analysis - Diversified Miners: Capital & Supply Discipline To Persist Despite Better Performance - APR 2017


BMI View: Major diversified miners will see improving financials and performance over the coming years as FY2016 marked the start of positive net incomes following years of losses. Nevertheless, miners will remain focused on capital and supply discipline, with debt reduction and efficiency enhancements despite improving commodity prices.

Major mining companies will now perform better over the coming years as 2015 marked the bottoming out of the mining downturn. In FY2016, large diversified mining companies such as Anglo American, Glencore, Vale, and Rio Tinto posted positive net incomes for the first time in years. Not only did they make profits, they were also successful at debt reduction. For instance, Glencore made a profit of USD1.6bn in FY2016, and reduced net debt from USD 25.9bn at the end of FY2015 to USD15.5bn at the end of FY2016. Similarly, Rio Tinto, Vale and Anglo posted profits of USD4.6bn, USD3.9bn and USD1.6bn, respectively, following years of losses.

FY2016 To Be Start Of Better Performance
Select Diversified Miners - Net Income Available to Common Shareholders (USDmn)
Source: Bloomberg, BMI

Rio and Anglo American managed to reduce their net debts to below USD10bn each, specifically to USD9.6bn and USD8.5bn, respectively, at the end of FY2016 compared to USD 13.8bn and USD12.9bn at the end of 2016. Amongst these major miners, Vale was least successful at reducing debt, with a marginal decrease from USD25.2bn at the end of FY2015 to USD25.1bn at the end of FY2016. We believe miners will remain committed to debt reduction in 2017 and beyond, along with which their performance will continue on the uptrend. Reduced cost of debt servicing as interest payments decrease with debts paid off will contribute to better balance sheets. Most major miners have decided to restart dividends from 2017 onwards.

Rio Tinto A Steady Winner
Select Mining Companies - EBITDA Margin (%)
Source: Bloomberg, BMI

Prices Will Not Be Main Driver Of Diversified Miner Performance

Although we believe that most commodity prices will improve over the coming years, albeit modestly, prices will not be the main driver of diversified miners' better performance in the coming years. Instead, cost reduction and efficiency improvement will be the sources of strong balance sheets, improved cash flows and overall better performance. Glencore, Rio Tinto, Vale and Anglo's improved performance in 2016 were attributed to their strong cost reduction and efficiency enhancement drives. This is because as diversified miners', the gains they made from improving prices of commodities such as iron ore, zinc, gold and coal were offset by lower prices of commodities such as copper and nickel on average in 2016. Glencore was unable to benefit from increased coal prices in H216 as the company had locked-in Q216 prices for H216 and Q117 as part of risk management and hedging.

Labour Costs To Be Reduced Further
Select Mining Companies - Number Of Employees
Note: Data u navailable for Glencore from years 2006-2011 and Rio Tinto for year 2008. Source: Bloomberg, BMI

We also believe that the benefit diversified miners had from weaker emerging currencies in 2016 will no longer come to their aid in 2017. As an example, the depreciation of the Kazakh tenge and the South African rand relative to the US dollar in 2016 that gave Glencore a substantial advantage in lowering operating costs will not persist in 2017 as we expect both currencies to appreciate (see: ' Currency Forecast - KZT - Appreciation Ahead As Oil Price Rises ' , February 16). In the case of Vale, however, the 17% appreciation of the Brazilian real against the US dollar in 2016 helped with debt servicing as the company's debts are in USD, and this will continue with further appreciation of the real ahead (see: ' Currency Forecast - BRL: Investor Interest Amid High Real Rates Supports Strength ' , January 3 2017).

Stronger Emerging Currencies A Disadvantage For Miners
Exchange Rate Of Select Emerging Market Currencies With The USD
Source: Bloomberg, BMI

Supply Discipline To Continue Despite Improving Prices

While prices of most commodities will fare better over the years, we expect miners to remain disciplined in terms of production. Glencore's guidance for 2017 shows a 5% decrease in copper production, and minimal increases of 9% for zinc, 2% for lead, 4% for nickel, and 8% for coal. Similarly, Rio Tinto has adopted a 'value over volume' approach and expects minimal increases in production of 2% for bauxite, 1% for aluminium and iron ore, and 0.3% for copper in 2017. Vale will increase iron ore production by 5% in 2017 with its new S11D mine in Brazil, while Anglo will roughly maintain production of all its commodities at 2016 levels except for diamonds which will see a 15% increase.

Capex To Remain Stringent
Select Mining Companies - Capital Expenditures (USDmn)
Note: est = Bloomberg estimate. Source: Bloomberg, BMI

Capital Expenditures On Tight Grip

Overall, despite improving operating cash flows across the board, capital expenditures will remain stringent over the next three years in terms of absolute value, as miners will continue to pursue a strategy of greater capital discipline. This will ensure miners have greater free cash flows going forward to weather market volatility than in past years. Miners will continue investing in technology - all the more so that technology will help them improve efficiency further - and expand growth assets, but there will be minimal investment in greenfields projects. Glencore will look to grow its copper and zinc assets with a USD4bn annual capital expenditure target going forward.

Rio To Remain Outperformer In Terms Of Efficiency
Select Miners - Iron Ore Production (mn tonnes) & EBITDA per metric tonne (USD)
Source: Bloomber, BMI

Rio Tinto will focus on developing existing projects, such as Amrun and Oyu Tolgoi, while Vale lowered its yearly capital expenditure to USD4.5bn from 2017 onwards compared to the USD5.8bn figure in 2016. Similarly, in 2017, Anglo will continue maintaining strict capital and cost discipline, with capital expenditures unchanged from 2016 at USD2.5bn. We also expect merger and acquisition activity in the mining space to slow as more miners will be holding on to their assets in the coming years with most non-core assets already shed by FY2016. For example, Freeport Mcmoran Inc has announced in October 2016 that the company will no longer sell their mining assets. Anglo also announced that asset disposals are no longer required, and it will retain its Moranbah, Grosvenor and nickel assets.

Vale To Increase Share Further With S11D Mine
Absolute Global Production Of Select Commodities (mnt) & Select Miners' Share Of Production (%)
Source: Bloomberg, BMI
Financial Information Of Major Diversified Mining Companies
Company Vale Rio Tinto Anglo American Glencore
Note: Values in USDmn. Source: Bloomberg, Company Reports, BMI
Year FY 2015 FY 2016 FY 2015 FY 2016 FY 2015 FY 2016 FY 2015 FY 2016
Revenue 23787.33 27316.72 34829 33781 20455 21378 170497 152948
EBITDA -4027.26 10411.51 8523 11589 -1880 3804 8079 7715
Net Income Available to Common Shareholders -13473.3 3842.468 -866 4617 -5624 1594 -4964 1379
Profit Margin -56.6406 14.0664 -2.4864 13.6674 -27.4945 7.4563 -2.9115 0.9016
Historical Market Cap 16953.26 40662.04 52751.78 70146.03 5667.459 18472.21 18957.59 49285.95
Capital Expenditures -8207.05 -5006.31 -4685 -3012 -4053 -2418 -5372 -3048
Net Debt 24905.33 25094.59 13593 10191 11072 7118 41303 30700