THE world’s largest mining companies were putting their futures at risk by choosing to pay dividends before re-investing in their businesses, said Mick Davis, the former CEO of Xstrata.
Responding to questions at the Joburg Indaba conference, Davis acknowledged the important strides mining firms made in stabilising following the commodity price correction of 2013 to 2016. This was a period when the mining sector’s high debt, fuelled by unbridled expansionism, was exposed, sending investors scattering.
There were many examples of how “once grand” mining firms, such as Rand Mines in South Africa, had become extinct after failing to reinvest, said Davis. “It was once the biggest mining company in the world,” he said.
“Mining majors have addressed their fundamental costs and all of them have done a fantastic job; making themselves more resilient as a result of doing that.
“Anglo American is a very good example of that. A few years ago, Anglo American was in a very bad shape, whereas now it is in an entirely different position,” he said.
At Xstrata, Davis proposed in 2009 a ‘merger of equals’ with Anglo American then led by Cynthia Carroll. The bid was eventually repelled although Carroll was three years later replaced by Mark Cutifani who is Anglo’s current CEO.
Said Davis: “As a result of the retardation of investment programmes, they [mining majors] have been able to return significant forms of cash and dividends to shareholders. They have satisfied the needs of the investment community.
“Therein lies their biggest challenge going forward. Directors and management teams have not focused on this very simple proposition: every day they take something out of the ground and unless you do something that replaces that, you end up withering and dying.
Davis said that “some value creation” could be achieved by lowering the cost base which made mining grades more payable, but more value comes from reinvestment which increased options. “The ability to create value depends upon the options you have available in your portfolio.
“I fear that this very focused approach on returning cash to shareholders in the form of dividends and capital returns has not in fact taken into account sufficiently the need to reinvest and so has not created optionality.”
Mining companies therefore faced a trend of declining NPVs (net present valuations) which would reflect in the share prices as the value of future cash flow declined.
Olivia Markham, MD, of Black Rock’s natural resources, said the mining sector was at the point when reinvestment had become necessary, although it could be accommodated in a framework that also allowed for continued shareholder returns.
“From 2019, balance sheets are strong, capital allocation is good, but for many companies growth is lacking. I’ve been worried about whether we see low returning growth come back or a splurge in M&A.
“I am conscious that there is a point when we have to start investing in growth and we are at the point. My hope is that with commodity markets becoming tighter, returns are more robust.”
“I think there is a permanent change,” she said of the mining companies installing regular investment returns, adding that of the indiscipline of 2011 to 2016 was a moment “… when we got all caught up in the euphoria of the phenomenal demand event that was China industrialisation”.