(Financial Times) – Anglo American set the sombre tone. Falling prices and rising costs enfeebled the mining group’s businesses in the first half of the year, halving earnings.
First among its diversified cadre to report, the miner last month pruned its spending plans on high-profile growth projects. It is now — as earnings season approaches its conclusion — a familiar tale. The mining industry faces a number of negative factors that are squeezing earnings, curtailing cash flows and forcing management teams to make tougher choices.
The backdrop to the lacklustre results is the concern over whether the so-called “supercycle” is drawing to a close after years of surging Chinese demand combining with supply constraints from decades of under-investment to send prices higher for commodities such as copper, coal and iron ore.
BHP shelves Olympic Dam expansion The debate is crucial to mining companies and their investors. Over the long term, the performance of mining equities is largely correlated with commodity price fluctuations. Increases in costs, especially wages and payments to governments, tend to lag behind booming profits as prices rise, putting severe pressure on the sector’s profitability.
Mining chief executives argue that China’s hunger for steel-producing commodities, iron ore and coking coal, as well as copper and other metals will remain robust.
“The bull run can’t last forever,” says Rachael Bartels, managing director of Accenture’s mining industry group. “But the underlying demand for commodities is not going to go away. China and India are not finished with urbanisation and Africa hasn’t even started yet.”
Yet mining companies face a dramatically more challenged outlook than even a year ago — and their latest earnings underscore the issues to watch in the sector.
Miners including Xstrata, Anglo and ENRC have reduced their spending on growth projects this year, many pledging to review future plans as well.
BHP Billiton, more dramatically, took its $20bn Olympic Dam expansion project off the table, arguing it no longer made economic sense.
“Six months ago, [the miners] were like bulls at a gate in terms of trying to see who could spend more money,” says Rob Clifford, analyst at Deutsche Bank. “Now there is a lot more caution.”
The real story behind the pullback, argue executives and analysts, is the collapse in the industry’s cash flows. Underlying earnings before interest, tax, depreciation and amortisation — a proxy for cash flow — fell between 20 and 40 per cent from the second half of last year to the first half of this year.
Rio Tinto’s earnings per share fell about a fifth year on year, note analysts at Citigroup, who say its operating cash flows fell 60 per cent — close to levels not seen since the 2009 financial crisis.
Some miners’ first-half cash flows did not cover their capital expenditure and dividends. The industry’s debt levels are expected to keep rising. “We are likely to use a little bit of balance sheet capacity if current conditions prevail,” said Marius Kloppers, chief executive of BHP Billiton. “This is what balance sheets are for.”
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