Global mining and metals companies’ focus on debt reduction is in danger of going too far and compromising long-term growth.
According to a new EY report, “Does Cutting Debt Have to Mean Reducing Your Ambitions?,” debt has fallen by almost 25% in the sector from peak levels in 2014 following the end of the super cycle, with the majority of debt reduction happening in 2016.
The report analyzes the top 50 mining companies in the world by market capitalization and reveals that, in 2016 alone, debt fell by 17% (approximately US$39b) year-on-year. It identifies proceeds from asset sales, curtailed capital spending and suspended dividends as contributing factors to reduced debt.
“A relentless focus on cash optimization through cost cutting and productivity improvements over the last few years, in addition to a recovery in commodity prices, has led to remarkably low debt in the mining and metals sector,” says Lee Downham, EY Global Mining & Metals Transactions Leader.
“Companies have increasingly shifted capital structures to equity, increasing flexibility but resulting in higher overall cost of capital.
“Restoring dividends and implementing capital return programs to shareholders is indicative of a cautious mindset across the sector and one that could hinder growth ambitions and, ultimately, companies’ abilities to generate attractive returns.”
Gearing – the ratio of net debt to equity – dropped to 34% among the top 50 miners in 2016. The report outlines how, should the sector continue to pay down debt at the same rate, net debt would fall by around 20% in 2017. This kind of further reduction in debt will result in less efficient capital structures among companies and further question their ability to generate returns, which are already relatively lower than other sectors.
Downham says: “Companies face the very real risk of letting debt levels fall to lows that create inefficient balance sheets and overlooking necessary investment in projects to generate returns down the road. The cautious mindset that has helped many companies weather volatility over the last few year could now become their biggest obstacle to future growth.”
Reduced growth ambition is translating into lukewarm transaction activity in the sector. Momentum generally remains subdued, as participants continue to be cautious about global demand growth and ongoing volatility. Deal volume in the first quarter of 2017 grew minimally by 6.5% over the same period in 2016 and fell by 18% quarter-on-quarter.
Downham says: “Exploration spend has deteriorated in recent years and project pipelines remain challenged. We expect companies to increasingly look to make the difficult call on which portfolio to choose and to back investment as many realize perfect investment conditions may never materialize.”