Mining cycles tend to repeat themselves. Once prices bottom out, cash profits can only improve, and pave the way for first balance sheet repair, then free cash flow and finally capital returns. As the share buyback and dividend plans of London’s largest listed miners show, we are firmly in the latter stage.
Yet given the caution miners such as Rio Tinto (RIO), Anglo American (AAL) and BHP Billiton (BLT) have applied to growth and capital expenditure, it is not altogether clear what comes next. Last week, analysts at Jefferies laid their cards on the table, publishing a note predicting that the sector’s corporate priorities could soon be “more about M&A and less about projects”.
The arguments behind this call are manifold. Chief among them are a depleted project pipeline and corporate austerity, which the bank believes will remain “the name of the game”. Rising geopolitical risk and higher costs brought about by higher environmental and regulatory standards only add to the reluctance of boardrooms to sanction multi-phase developments that take years to develop.
Currency is less of an issue. Because miners mainly account and sell in US dollars, London-listed groups are somewhat insulated from any relative weakness in the pound. However, companies with sought-after commodities are more likely to be targeted. Earlier this month, Toronto-listed miners Lundin and Euro Sun disclosed they had made a C$1.5bn (£870m) bid for Nevsun Resources. Although it was rejected, the approach sparked speculation that the copper market may be on the brink of consolidation, ahead of looming supply shortfalls.
In its note, Jefferies cautioned that sector conservativism would likely hold back “large scale M&A”, but said it expected bolt-on acquisitions to “progress to large transformational deals”.
Another potential catalyst for this trend is tighter monetary policy. “As interest rates increase, the attractiveness of a high dividend yield fades and bond proxies perform poorly,” argues Jefferies. “Meanwhile, investors begin to look for mining companies with growth,” which the bank suggests “can be a function of project development and/or M&A.” The latter scenario is more likely to prevail – or so the thinking goes – due to a now-entrenched aversion to oversupply risks, and inherent desire to prop up prices.
In the last 18 months, a focus on price over market share certainly appears to have been Rio Tinto’s lead strategy. Setting the benchmark for investor redistributions, the iron ore giant announced and executed $8.2bn-worth of cash returns in 2017, including the $1.9bn share buyback following the sale of its Coal & Allied division. On Rio’s numbers, that was more than Anglo, BHP, Glencore and Vale put together. The figure also equated to 49 per cent of Rio’s operating cash flow and disposal proceeds – compared with an average of 16 per cent for the peer group.
But this belies a dearth of organic growth options, relative to the rest of the market. Indeed, Jefferies singles out Rio alongside majors BHP, Vale and South32 (S32) as the most likely acquirers in an M&A spree. Vedanta Resources (VED), whose owner Anil Agarwal fed the rumour mill when he launched a bid for £2bn-worth of shares in Anglo in 2017, may be further down the predator pecking order.
