It feels like we are approaching another turning point in the industry
Thursday 28 Feb 2019 Author: Daniel Coatsworth

Large cap mining companies have been great performers this year with an average gain of 15.3% versus 7.2% from the FTSE All-Share.

Commodity prices have been picking up in general, there is increasing optimism that US/China trade talks will reach an amicable conclusion, and China’s latest stimulus measure is giving hope to the market that the country’s ferocious appetite for commodities will continue.

Against this backdrop we have an interesting situation bubbling away with some of the biggest players. Both Glencore (GLEN) and BHP (BHP) missed earnings forecasts with their latest half-year results and it is no surprise that their share prices are the laggards relative to the sector.

Glencore has a cocktail of problems to overcome, namely a US Department of Justice probe into money laundering and unfavourable changes to mining laws in the Democratic Republic of Congo which is pushing up royalty rates, imposing new taxes and introducing policies that will restrict the repatriation of profits.

Its decision to limit coal activities may pacify some investors who had environmental concerns about its involvement with the commodity, yet it does not get over the fact that Glencore is still a major producer of coal.

BHP needs to show that recent operational issues were one-offs and that it is capable of producing much-promised productivity gains.

ARE WE AT A TURNING POINT?

Both miners are profitable and arguably have debt under control, yet they don’t appear to be companies at the top of their game. And this is where it is interesting. It feels like we’re at a turning point in the industry cycle and investors might soon get a bit twitchy over where companies go next.

Miners shackled by their own problems run the risk of being left behind, or making the wrong decisions, if there is another growth wave in the sector.

Seven years ago the commodities bull market reached its peak and miners started to go through a long period of turmoil. They had to write down the value of assets – the punishment for having previously overpaid for acquisitions. Operations were either trimmed or sold and reduced cash flow had to go towards debt repayments first and foremost.

Miners became leaner entities and emerged in a better state once commodity prices started to pick up. Investors have enjoyed very generous dividends and the benefits of share buybacks over the past few years and that trend is still in play today.

Capital returns from asset sales and cost savings from mine restructuring will only go so far towards appeasing investors. It feels like the market could soon place a greater focus on the future and demand miners present clear strategic plans for growth.

But who would be bold enough to make the first move with a chunky acquisition? After all, some investors may have reservations about aggressive growth sprees given the mistakes made last time round.

Being cautious may prevail in the near-term which means investors can expect a continuation of the strong dividends and buybacks. Yet this tune can’t play forever and at some point the growth cycle will start again.

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