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Debt Levels and Leverage Have Soared in the Mining Industry

Ascension Day coincides this year with mid-spring and Europe Day, and there is rising optimism in the mining industry. 

I am writing this blog on an auspicious date in the calendar. Thursday, May 5, is 40 days into Easter, and so Christians are celebrating Ascension Day. The date also marks the halfway point of spring (in the northern hemisphere) and is Europe Day, which is an annual celebration of peace and unity in Europe.

On a day associated with spring and rising, it is perhaps appropriate to remind ourselves of the mining industry's upbeat performance so far this year.

Despite a sharp correction this week, metals prices overall have performed well in 2016, albeit from a very low base. The best performers have been iron ore (with the price of 62% Fe material up 40%), gold (22% higher) and zinc (up almost 19%). Thermal coal has risen nearly 10%, and nickel and aluminum by over 8%. Amongst the major metals, copper has been the laggard, up barely 4% in the year so far.

As noted by the SNL Metals & Mining analysts in the soon-to-be-published State of the Market report for the March quarter, these rising metals prices have been reflected in increased takeover activity. Although the number of reported mergers and acquisitions fell to 25 during the three months to end-March, from 39 in the December quarter, the value of these deals jumped more than a third from US$2.62 billion to US$3.53 billion. As usual, gold transactions dominated, accounting for 47% of the total value.

The top two deals came from nations that do not often feature at the top of the ranking — Japan and Sweden. The largest transaction (still pending) during the first three months of this year was Sumitomo Metal Mining's US$1.0 billion offer for Freeport-McMoRan's 13% share of the Morenci copper mine in Arizona. The second largest was Boliden's US$712 million offer in March for First Quantum Minerals' Kevitsa nickel mine in Finland.

Unfortunately, financing has not kept pace. Funds raised during the first three months was a reported US$9.21 billion, which is down from the US$10.01 billion raised in the year-ago period and the US$12.85 billion raised in the December quarter, 2015. Most of the shortfall was in funds earmarked for Latin America.

The combination of acquisition activity, restrained fundraising and low corporate earnings over the past few years has resulted in sharply higher debt for the international mining industry. SNL estimates that total industry debt was US$669 billion at the end of 2015, with some 44% of this being held by Chinese mining companies. Although 4% lower than the peak in 2014, total debt is still three times the level prevailing in 2006.

The 2,800 listed mining companies in the SNL Metals & Mining database, an offering of S&P Global Market Intelligence, had net debt of almost US$464 billion at the end of last year. With earnings under pressure, leverage has soared. Our analysts estimate that corporate net debt as a multiple of EBITDA now exceeds 3.9x for iron ore producers (for whom it was only 1.2x in 2011) and, at the other end of the commodity range, a relatively respectable 1.9x for gold producers (compared with just 0.3x in 2011). Net debt is calculated as a company's interest-bearing liabilities minus cash and cash equivalents, and EBITDA is the company's earnings before interest, tax, depreciation and amortization.

Hardly surprising then that our analysts expect the mining industry's capital expenditure to fall for a fourth successive year in 2016, to under US$230 billion. Although there is growing optimism in the mining industry, don't expect capital expenditure to spring back until next year at the earliest. 

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