Mining For Opportunities Amidst Downturn

BMI View: The pain in the global mining industry is far from over as the Chinese economy enters a protracted period of less commodity-intensive growth in the coming years. Lower mineral prices will continue to reshape the long term growth strategies of the larger miners and threaten the short-term survival of cash-strapped juniors. While mining sector's fortunes will remain challenged by the fading of the commodities boom, several positive themes will stand out to partially arrest pessimism in the industry. Below, we highlight the key challenges and opportunities that are set to dominate the headlines over the coming quarters.

Challenges

1. More Pain Ahead As China Slows

Less Commodity-Intensive Growth
China - Select Economic Indicators, Real Growth (% y-o-y)

Mining For Opportunities Amidst Downturn

BMI View: The pain in the global mining industry is far from over as the Chinese economy enters a protracted period of less commodity-intensive growth in the coming years. Lower mineral prices will continue to reshape the long term growth strategies of the larger miners and threaten the short-term survival of cash-strapped juniors. While mining sector's fortunes will remain challenged by the fading of the commodities boom, several positive themes will stand out to partially arrest pessimism in the industry. Below, we highlight the key challenges and opportunities that are set to dominate the headlines over the coming quarters.

Challenges

1. More Pain Ahead As China Slows

We believe the pain in the global mining industry is far from over. Disappointing economic performance by China will dilute a crucial pillar of support for commodity prices in the coming years, and by extension, the mining sector. We forecast Chinese real GDP growth to average 7.1% in 2014, before slowing further to an average of 6.1% over the next five years.

Less Commodity-Intensive Growth
China - Select Economic Indicators, Real Growth (% y-o-y)

With China's economy on course to enter a protracted period of slower and less commodity-intensive growth, key minerals such as iron ore and copper are set to see their prices weaken significantly over the coming years. The wave of asset write-downs and divestitures that took place over the course of 2013 will continue as mining companies struggle to right their ships amidst the mining downturn. A slew of challenges are now coming to the fore with the fading of the commodities boom, which has over the past decade, masked the impact of rampant cost inflation, falling ore grades and poor capital discipline in the mining space.

2. Consolidation To Gather Momentum

In contrast to the headlong pursuit of volume growth, we believe miners across the board will be forced to deploy greater capital discipline and cost-containment measures to their current operations. Brownfield projects should continue to take precedence, while the inherently higher-risk nature of greenfield developments sees these projects succumb to investors' pressure for assets that deliver a demonstrable return on capital. Massive projects such as Barrick Gold's Pascua-Lama mine, GlencoreXstrata's Tampakan project and Anglo American's Pebble mine have all been suspended or delayed in 2013 due to weak market conditions.

Greenfield At Risk
Select New Copper Projects - Copper Equivalent Capex Intensity (US$/tonne)

The growing risk aversion of mine financing from both the debt and equity markets, coupled with the meltdown in gold prices, will further constrain the ability of miners to embark on new projects. As spotlighted by the chart below, the capital expenditure of the top 10 miners (which accounts for 80% of the industry spending) plunged by 16.9% year-on-year (y-o-y) in 2013. This is expected to be followed by y-o-y falls of 9.2% in 2014 and 12.1% in 2015.

Austere Times
Select Mining Companies - Consensus Estimates for Capital Expenditure (% chg y-o-y)

We expect the global mining industry to undergo significant restructuring over the coming quarters with the exit of marginal producers and projects that are economically unviable ( see 'Consolidation To Engulf Mining Industry', July 25, 2013). In particular, the evaporation of mine financing will see a growing number of juniors hit the wall and cease operations altogether, while a handful of larger miners look to expand their production pipeline by acquiring other players sitting on a strong claim.

Additionally, the 'mergers of equals' strategy could gain traction as some of the juniors look to achieve greater economies of scale and enhance their ability to tap into bigger chunks of finance. A recent study by Bloomberg revealed that a third of public miners are armed with less than three months of cash on hand, a situation that has deteriorated markedly since 2012.

Junior Miners In Distress
Global - Mining Initial Public Offerings (IPOs)

3. Frontier Mining Losing Shine

In our view, frontier mining will become increasingly less attractive over the coming quarters. Despite the rich deposits of untapped minerals in many frontier markets, the softening of commodity prices will force miners to engage in greater self-criticism of their expansion plans.

Frontier markets are often beset by a spate of regulatory and logistical hurdles which marked the path towards mine development a particularly challenging road. Indeed, the development of headline-grabbing projects such as the Ring of Fire mining development in Canada feels almost as distant today as it did when it was first discovered in 2007. A breakdown in negotiations with the provincial government, along with staggering infrastructure constraints, massive cost overruns and waning interests from investors are amongst the many reasons behind the debacle of the project in Ontario, Canada.

Rocky Road
Select Countries - Logistics Rating

4. Rising Environmental Pressures

We believe rising environmental concerns will remain a key challenge for the mining industry over the coming quarters. Mining operations around the world are feeling the heat of shifting regulations and growing social protests aimed at curbing mining-related pollution. Notably, water scarcity is fast emerging as the next big challenge for miners as governments are becoming aware of the need to conserve supplies for domestic agricultural and municipal use ( see 'Water Scarcity The Next Big Challenge For Miners', February 25, 2013). To be sure, recently proposed legislation in Chile is mandating miners to use desalinated water instead of freshwater resources due to escalating risk of water shortages in the northern region ( see 'Further Cost Challenges Ahead', January 07, 2014).

Water Scarcity A Major Challenge
Global - Water Stress Levels

Opportunities

1. Asia's Hunt For Minerals Continues

Despite the looming slowdown in the Chinese economy, we expect China to continue expanding its mining footprint abroad. The absolute increase in commodities demand will continue to impress as China grows a much larger economic base. Most importantly, policies aimed at enhancing supply security and reducing its reliance on foreign-owned sources will prompt more Chinese investors to scoop for mining assets overseas. This should underpin continued investment in the mining sector, with minerals such as bauxite, iron ore and gold attracting the bulk of mining interests. China's continued reliance on coal-fired power generation over the next decade should embolden the trend of rising capital flows into countries such as Mozambique and Zimbabwe, where rich coal deposits are located.

Chinese Production Shortfall To Drive Overseas Ventures
China - % Of Global Production And Consumption (2012)

Apart from China, a structural shortfall in the production of coal and iron ore in India will further encourage the development of mining projects in countries such as Guinea, Botswana and Sierra Leone. We expect Africa to be the key destination for Indian mineral sector investment as the continent is rich in high-grade untapped reserves that are vital to the long-term growth of India ( see 'The Coming Boom In India-Africa Mineral Investment, December 07, 2012). Nonetheless, we are aware that mining companies will continue to encounter steep hurdles in their forays into Africa. Many of the African countries are plagued by a paucity of sound infrastructure and often suffer from instable political regimes.

2. Private Equity To Enter Funding Void

We believe the depressed valuations of mining companies and the record amounts of uncalled capital sitting in the private equity (PE) industry will continue to amplify the PE push in the mining space (s ee 'PE To Gain Traction Amidst Mining Downturn', October 01, 2013). According to Bloomberg, a record 13 new mining-related PE funds raised capital in 2013, contributing to the three-year surge in fund raising to US$15bn. PE firms including Resource Capital Partners (RCP), Apollo Global Management (Apollo) and X2 Resources have all held a series of successful closings for investment into the mining sector last year.

We expect this trend to gain traction over the coming quarters as cash-strapped miners battle with limited access to traditional mine financing and turn to PE to fill the funding gap. Alternative forms of financing such as streaming transactions, royalties and off-take agreements could also garner growing interests from miners with producing or near-production assets.

3. Asia To Remain Reliant On Seaborne Coal

In contrast to the fading appeal of coal in many western markets, we expect Asia to remain reliant on seaborne coal over the next decade ( see 'Five Burning Themes In Global Coal', December 03, 2013). With energy poverty omnipresent in both China and India, coal will remain the only realistic option to providing cheap and abundant energy to the local population over the medium term.

Coal Not Going Away In Asia
Select Regions - Coal (As % of Total Electricity Generation)

Against the backdrop of resilient demand growth for thermal coal in Asia, we expect global coal trade flows to continue their profound shift from the Atlantic to the Asia-Pacific basins in the coming years. This sustained rise in coal tonnage towards Asia will not only benefit coal miners, but also offer investment opportunities in the infrastructure and shipping sectors. Indeed, Russia's push for more coal towards Asia is fuelling a growing number of companies to undertake infrastructure and port development projects in the Far East. Furthermore, Asia's continued reliance on thermal coal imports should soften the blow of faltering demand growth for iron ore from China for the dry bulk shipping sector.

Asia Fuelling Trade Dynamics
Global - Coal Imports (mnt, LHS) & Exports (mnt, RHS)

4. Mining Services Firms To Continue Outperformance

While the current mining downturn will keep mine service firms under pressure in 2014, we believe it is certainly not all gloomy in the mining servicing industry. Specifically, we expect mining suppliers (represented by the Bloomberg World Mining & Construction Index) will continue to outperform the mining complex (represented by the Bloomberg World Mining Index) over the coming quarters.

Equipment Makers In Better Position
Select Indices, Rebased

This outperformance will be due to two key reasons. First, of paramount significance to many mine service and equipment providers, mined tonnage will continue to increase in absolute terms despite the pullback in supply growth ( see 'Mining In Austere Times: Winners & Losers', October 24, 2013). This is particularly the case for bulk minerals such as coal and iron ore that are especially dependent on support from the heavy industry. Greater mined volumes should underpin continued demand for construction equipment and mining services over the long term.

Still Growing In Absolute Terms
Global - Coal & Iron Ore Production (mnt)

Second, in contrast to the miners, suppliers of mining equipment generally enjoy quicker cash flow as they are often paid at least partially upfront upon the granting of work contracts. Mining companies, however, require years or even decades in some instances before they are able to realise cash flow from production.

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