Mining report: Bull market buys mire miners in bear realities

Viability of ambitious resource projects evaporating as commodity prices stall
Sid Rajeev, head of research with Vancouver-based Fundamental Research Corp., said cutting capital expenditures is key to streamlining operations at mining firms

The mining sector remains mired in a sluggish bear market because of the acquisitions producers made when commodity prices, particularly gold, were at an all-time high two years ago, analysts say.

According to Mickey Fulp, noted writer and analyst known as the Mercenary Geologist, mining companies, buoyed by skyrocketing commodities prices, bought or developed mines they otherwise wouldn’t have because they wanted to capitalize on the inflated market.

But Fulp told Business in Vancouver said that because of the drop in commodity prices, both mid-tier and major firms are now shedding bad or non-essential assets to free up much-needed cash.

“What we saw was – I would call it a Wall Street style of capitalism – where companies were focused on increased reserves, increasing production and emphasizing the quantity of ounces of gold or pounds of copper produced versus the quality of those ounces or pounds.

“As a result, they made bad acquisitions in an attempt to grow, they lowered cut-off grades, they reduced their margins of operating costs over the price of metal. Mining, in my estimation, is not a growth industry, it is a value industry. The mining companies got away from that caveat of the industry.”

But streamlining portfolios takes time, and Fulp expects such cost-cutting measures to continue into 2014’s fourth quarter.

He added that there is “no catalyst on the near-term horizon” that will change the current bear market.

Sid Rajeev, head of research at Fundamental Research Corp., echoed Fulp’s sentiments. Rajeev said the valuation of resource equities comes down to a simple equation: cash from operations minus capital expenditure (capex). But when capex increases faster than cash flow – as it does when companies focus solely on growth – value eventually drops. All but six of BIV’s top 20 mining stocks lost share value.

“A lot of capital was raised for exploration and development in the past,” said Rajeev, “but a lot of companies were running behind highly ambitious, capital intensive projects. But when the markets turn and there is a financial crunch, all of a sudden these projects aren’t viable.

“The good thing is these companies are evaluating growth strategies, cutting their capex spending and how to optimize operations to reduce cost.”

David West, a Vancouver-based mining analyst with Salman Partners, agreed with Fulp and Rajeev. He said mining companies are “cutting costs top to bottom, left to right, closing offices, trimming management and making tough decisions on assets” to save money. But, like Fulp, West said it would take time before mining companies can right their fiscal ships. West likened the current struggles of the mining world to driving a semi-trailer the wrong way on a two-lane highway: it takes a long time to turn around.

“If your focus is on growth – and this goes for any mining company – and all of a sudden the gold price drops from $1,700 to $1,300 in a short period and the focus quickly turns away from growth,” said West. “But it can’t happen overnight.”

Among the struggling sector, there have been a handful of notable purchases. For example, Capstone Mining (TSX:CS) completed its US$650 million acquisition of the Pinto Valley Copper Mine from BHP Billiton (NYSE:BHP) in October, and B2Gold (TSX:BTO) bought Volta Resources (TSX:VTR) for US$63 million.

Last summer, B2Gold raised US$259 million in debt financing, prompting industry watchers to speculate on the company’s intentions to make a major purchase.

West said companies with good balance sheets will be able to buy discounted projects in the current climate but stressed that mining firms will have to be more thrifty in the future to avoid writedowns when prices drop.

“Eventually there will be a progression toward mergers and acquisitions,” said West. “But it will be more frugal this time. You won’t see overpaying, they will be more frugal.” 

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