review of global trends in the mining industry may 2004
TRANSCRIPT
mine*review of global trends in the mining industry
may 2004
*connectedthinking pwc
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Contents
Introduction 1
Highlights for 2003 2
Executive summary 3
Aggregated industry income statement 4
Aggregated industry statement of financial position 5
The industry in perspective 6
Financial performance 10
Financial position 16
Value 20
Health and safety 24
Mineral reserves 26
Market values vs book values 28
Hedging 30
Exploration 32
Environmental provisions 34
Directors 36
Sustainability 38
Political risk 40
Companies analysed 42
Glossary 43
PricewaterhouseCoopers 44
2 1
Introduction
Over many years, PricewaterhouseCoopers has, often in conjunction with regional industry bodies, conducted surveys of mining industry activity – looking at aspects such as historical financial performance, taxation regimes, exploration and development activity, health and safety performance and many other areas of relevance to the industry.
In 2003, PricewaterhouseCoopers launched the results of research identifying the industry-specific indicators that mining companies believe are critical to managing the value of their businesses, and contrasted these with the reporting priorities of investors and analysts. Our publication, Digging deeper – managing value and reporting in the mining industry, explored areas of importance to stakeholders and challenged companies to meet the requirements of analysts and investors in reporting results, risks and strategies in creating value.
This publication, mine* – review of global trends in the mining industry, provides an aggregated view of trends in the financial performance of the global mining industry in 2003, based on 30 of the largest listed mining companies across the world. It also looks at how companies have responded to some of the reporting challenges identified in Digging deeper.
We are confident that our findings will prompt debate across the mining industry and are pleased to provide the forum for that debate.
Hugh CameronGlobal Mining Leader, PricewaterhouseCoopers
Tim GoldsmithMining Leader – Australasiamine* project leader, PricewaterhouseCoopers
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Highlights for 2003
• Global market capitalisation of US$ 390 billion at March 2004, almost double that of 18 months earlier
• Revenue increased by 18% to US$ 110 billion, compared to US$ 93 billion in 2002
• Net profit margin of 10.4%, compared to 6.3% in 2002
• Capital expenditure increased by 21% to US$ 13.8 billion, compared to US$ 11.4 billion in 2002
• Return on capital employed of 7.6% compared to 4.7% in 2002
• Exploration expenditure increased by 9.1% to US$ 1.2 billion from US$ 1.1 billion
• Improving safety record with fewer fatalities than in the prior year in most territories
2003 2002Year-on-year movement %
US$ billion US$ billion
Revenue 110.3 93.2 ↑ 18.3%
EBITDA 29.1 21.6 ↑ 34.7%
Net profit 11.5 5.8 ↑ 94.9%
Cash on hand 12.0 10.3 ↑ 16.5%
Capital expenditure 13.8 11.4 ↑ 21.3%
Exploration 1.2 1.1 ↑ 9.1%
Key ratios
EBITDA margin 26.3% 23.2%
Net profit margin 10.4% 6.3%
Effective tax rate 26.3% 28.7%
Return on capital employed 7.6% 4.7%
Return on equity 10.5% 6.7%
Debt to equity ratio 28.4% 30.8%
(All amounts are for the respective financial years)
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Executive summary
The global market capitalisation of the mining industry as at March 2004 has doubled over the last 18 months and now stands at US$ 390 billion1. This is due to a number of factors, including the impact of a significant increase in demand from China. Hopefully we are seeing the start of the first mining boom of the 21st century!
Return on equity has increased from less than 7% in 2002 to over 10% in 2003, a welcome improvement. There is every indication that 2004 will be even better for the industry and should generate enhanced returns for investors. In the long term, the challenge for industry participants will be to ensure that acceptable returns can be achieved, even in the lower points of the commodity cycle.
Commodity prices have increased significantly over the last twelve months. As most mining companies have operations outside of the US, much of the positive impact of these price increases has been eroded by the weakening of the US dollar. Historically, the exchange rates for major mineral provinces such as Australia, Canada and South Africa have provided a natural hedge, such that local denominated commodity prices have not changed substantially. The structural change of global demand, whereby Asia is increasingly the key driver rather than the US, may have implications for the long-run trend in the US dollar, but so long as commodities are priced in US dollars, then the most important aspects of the natural hedge should persist.
The safety performance of the industry has improved in recent times. However, China’s official record of 6,000 fatalities in 2003 is clearly unacceptable, and the level of fatalities elsewhere also requires further improvement. The industry must continue to focus on improving the safety of the work environment.
The positive economic environment for the mining industry has assisted an upswing in exploration (albeit from a low starting point) and capital expenditure has also increased. However, the industry needs to proceed with caution. History has shown us
that bringing too much new production on stream in response to such a favourable environment has exacerbated the start of the decline of the global cycle. This boom-and-bust cycle has led to capital destruction and has driven investors away from the industry over time. The recent concentration of ownership (an outcome of the extensive industry consolidation over the last five years) should lead to better informed decisions on development and expansion opportunities, which in turn should better place the industry to manage the supply-demand cycle.
Governments are some of the most significant stakeholders in the industry. Their role can be crucial in ensuring the appropriate balance of incentives to kick-start mining and exploration growth while yielding appropriate returns for their citizens. They have a responsibility to ensure the local population obtains sufficient benefit from the mining industry through jobs, royalties, taxes and social infrastructure.
Governments that assist miners with favourable fiscal terms are far more likely to witness the growth of their industry. In due course, this will lead to higher returns through tax revenue. In a period of higher commodity prices, there is a temptation for cash-strapped governments to exploit short-term revenue opportunities notwithstanding the long-term impediment this could cause to exploration and development. We are already seeing some examples of this.
Digging deeper – managing value and reporting in the mining industry, PwC’s 2003 research survey of mining company indicators and what is reported to investors and analysts, highlighted some significant gaps between what companies are reporting and what stakeholders perceive to be important. Our analysis in this publication shows there is still some scope for companies to increase transparency, and unlock potential shareholder value, in important areas like mineral reserves, hedging and environmental obligations.
1Bloomberg, March 2004 3
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Aggregated industry income statement
2003 2002
US$ million US$ million
Revenue 110,330 93,169
Operating expenses (excluding amortisation and depreciation) 81,279 71,573
EBITDA 29,051 21,596
Amortisation and depreciation 10,283 9,055
Profit before interest and tax 18,768 12,541
Interest 3,226 4,372
Profit before tax 15,542 8,169
Income tax 4,087 2,342
Net profit 11,455 5,827
Explanatory notes for aggregated financial information
We have analysed 30 listed mining companies, representing 80% of the global industry by market capitalisation. Our analysis includes major companies in Australia, Canada, Latin America, South Africa, the United Kingdom and the United States. Due to lack of availability of current information, Russia and China are not represented.
The results aggregated in this report have been sourced from publicly available information, primarily annual reports and financial reports available to shareholders. Companies have different year ends and report under different accounting regimes. Information has been aggregated for the financial years of individual companies and no adjustments have been made to take into account different reporting requirements and year ends. As such, the financial information shown for 2003 covers reporting periods from 1 July 2002 to 31 December 2003, with each company’s results included for the 12-month financial reporting period that falls into this timeframe.
All figures in this publication are reported in US dollars. The results of companies that report in currencies other than the US dollar have been translated at the average US dollar exchange rate for the financial year, with balance sheet items translated at the closing US dollar exchange rate.
Some diversified companies undertake part of their activities outside of the mining industry, such as the petroleum business of BHP Billiton. No attempt has been made to exclude such non-mining activities from the aggregated financial information (except where indicated).
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Aggregated industry statement of financial position
2003 2002
US$ million US$ million
Current assets
Cash and cash equivalents 11,961 10,294
Inventory 14,291 11,489
Other current assets 19,837 16,536
Current assets 46,089 38,319
Non-current assets
Property plant and equipment 139,773 116,323
Investments 16,924 16,345
Deferred taxation 2,140 1,934
Goodwill 4,620 3,589
Other non-current assets 13,719 11,390
Non-current assets 177,176 149,581
Total assets 223,265 187,900
Current liabilities 34,172 31,615
Non-current liabilities
Long-term borrowings 43,288 38,711
Deferred taxation 13,367 10,686
Environmental provisions 8,380 6,711
Other non-current liabilities 14,797 13,238
Non-current liabilities 79,832 69,346
Shareholders’ equity 109,261 86,939
Total equity and liabilities 223,265 187,900
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The industry in p
erspective
The industry in perspective
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The industry in p
erspective
Sources of capital
The global mining industry had a market capitalisation of approximately US$ 390 billion as at March 2004, with its capital sourced predominantly from five exchanges:
• Australia• Canada• South Africa• United Kingdom• United States
This analysis reflects the fact that the three largest mining companies in the world – BHP Billiton, Rio Tinto and Anglo American, are all listed on the London Stock Exchange. The market capitalisation by primary exchange is geographically split as shown below.
Source: Bloomberg, March 2004
Market capitalisation by geography
Industry structure
Source: Bloomberg, March 2004
Industry structure
As shown on the right, mining companies with diversified operations account for 58% of the global industry, whilst the gold sector accounts for 19%. The diversified operations include significant operations in base metals, coal, iron ore, diamonds and uranium.
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The
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The industry in p
erspective
How has the industry performed over the last ten years?
Until recently, the sustained depression in metal prices restricted growth – as shown in the performance of the HSBC Global Mining Index below. However, the rally in the gold price over the past two years, followed by other base metal prices, has re-invigorated the industry. Much of the increase in industry capitalisation has occurred over the last eighteen months.
Industry consolidation has been significant
The past 15 years, and in particular, the last five years, have been a period of significant consolidation in the industry. This is demonstrated by comparing the market capitalisation of the ten largest mining companies in 1990 with the ten largest mining companies in 2004. The top three companies have remained intact, but their asset holdings are very different and their market capitalisations have increased substantially. Also, the only other companies that have retained their position in the Top 10 are Newmont and Amplats. A number of the key players in 1990, such as De Beers, Gencor, Driefontein and Reynolds, have disappeared as separate listed mining entities in their own right.
In the past couple of years alone, we have seen some significant consolidations, including Newmont’s acquisition of Normandy Mining/Franco Nevada, Norilsk’s acquisition of Stillwater, and Xstrata’s acquisition of MIM.
Source: DatastreamIndex May 94 = 1
Global Mining Index
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The
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The industry in p
erspective
1990 industry structure (top 10 market capitalisation of US$ 55 billion)
Current industry structure (top 10 market capitalisation of US$ 250 billion)
Source: Bloomberg, March 2004
Source: Xstrata presentation, JP Morgan conference, Sydney 2003
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Financial perform
ance
Financial performance
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Financial perform
anceThe beginning of a commodities boom?
Mining industry revenue increased by 18% from US$ 93 billion in 2002 to US$ 110 billion in 2003. Over half the increase in total revenues is attributable to five of the 30 companies analysed. These companies are listed below:
The increase in revenue is principally the result of commodity price and production increases. Acquisitions in the last two financial years by the companies analysed have also contributed to revenue growth.
Production increases have been driven by improved demand, particularly out of China. The rate of economic growth in China, coupled with the vast gap between its current level of development and that of the Western world, indicates that future demand for commodities in this region remains positive.
For the 30 months from 1 July 2001 to 31 December 2003, traded metal prices have shown a consistent upward trend. Whilst the outlook for each metal has different drivers and therefore expectations, the consensus view remains bullish.
Note: BHP Billiton’s 2002 revenue excludes their now divested steel business
Index July 01 = 1
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Financial perform
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The bottom line
2003 2002
Net profit margin 10.4% 6.3%
EBITDA margin 26.3% 23.2%
Return on equity 10.5% 6.8%
Return on capital employed 7.6% 4.7%
In absolute terms, the aggregate net profit of the mining companies analysed has almost doubled in 2003. Other profit measures, as summarised above, further illustrate the industry improvement experienced in 2003. The continued recovery in metal prices should lead to even better returns in 2004.
This is great news for an industry that has generated poor returns for many years. Even for 2003, the returns are not spectacular. However, it is encouraging to see an improvement and the industry has an opportunity to move beyond this in 2004 and beyond.
Only when the industry can consistently deliver acceptable returns can we expect to see greater weighting of mining investments in global investors’ portfolios.
A weaker US dollar has had an impact
Most of the 30 companies analysed have assets outside their country of domicile. Relatively few have significant operations in the US. This means that most of the companies analysed are sensitive to fluctuations in the value of the US dollar, with costs at operations outside of the US frequently rising in US dollar terms, to offset some of the positive impacts of an increase in dollar-based metal prices.
Those most significantly impacted have been the companies whose costs are denominated in Australian and Canadian dollars and to an even greater extent, the South African Rand.
Index July 01 = 1
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Financial perform
anceCompanies with operations in the natural hedge
Australia, Canada and South Africa have historically benefited from a ‘natural hedge’. The mining industry is so important to these countries that when the world economy was strong, led by US demand and commodity prices rose, so too did the AUD/CAD/ZAR exchange rates. As a result, commodity prices in local currencies were less volatile than they would otherwise have been.
Natural hedge – an example
South African company sells an ounce of gold at US$ 350 per ounce when the US dollar exchange rate is ZAR 9.0: US$ 1. Subsequently the gold price increases to US$ 400 per ounce and the Rand strengthens to ZAR 7.9: US$ 1. Total revenues under both scenarios are as follows:
Description Movement
US dollar 350 400 -14%
Rate of exchange 9.0 7.9
Rand equivalant 3,150 3,150 0%
Questions have been raised as to whether this natural hedge will continue in the new global economic environment. However, for the natural hedge to completely break down, movements in the value of the US dollar would have to be positively correlated with the value of currencies of commodity-producing countries, rather than negatively correlated as tends to be the case at present. It may well be that changes in the structure of the global economy, with increasing demand being driven from Asia, will have implications for the long-run trend in real US-dollar prices but so long as commodities are priced in US dollars, then the most important aspects of the natural hedge should persist.
Who is making the best margin?
Companies that experienced the highest profit margins in 2003 are outlined below. Implats, a low cost platinum producer based in South Africa, tops the list at 28%. With its primary operations in South Africa, however, the impact of the weaker US dollar can be seen in the erosion of the company’s profit margin year-on-year.
Once translated to local currency, the increase in the commodity price has been negated by the decrease in the US dollar.
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Financial perform
ance
Cash costs
Digging deeper identified that the disclosure of cash costs is important. Of the companies analysed, however, only half disclosed cash costs in their annual report. With the Gold Institute setting a global standard for the calculation of cash costs, gold companies led the pack in terms of reporting cash costs.
This measure clearly has merit in terms of assessing whether positive cash returns can be made from operations, but it does not reflect the value of sunk costs. There is evidence that some mining companies focus too heavily on cash costs, which undermines confidence in the industry amongst investors.
Return on total capital employed should receive greater emphasis, since it provides an indication of how effectively a company has invested in new capital.
The government take
Governments have benefited from the improved profitability of the industry. Corporate income taxes have increased by US$ 1.7 billion to US$ 4.1 billion in 2003. Notwithstanding this, the effective tax rate for the industry decreased by 3% from 29% in 2002 to 26% in 2003.
It is dangerous to draw conclusions on the effective tax rates of the industry. Further analysis of PwC’s Effective tax rates in the mining industry provides additional information on income tax rates in the industry and is available from your local PwC mining industry professional.
Mining companies have access to a number of tax incentives across many jurisdictions. Typically, incentives include tax holidays and notional tax deductions such as ‘percentage depletion’ in the United States or the ‘double deductions’ for exploration expenditure in Argentina. The global mining effective tax rate of 26% compares favourably with many other industries. For example, a survey of the effective tax rates of 16 global technology and media companies showed an average tax rate of over 40% for that industry group.
However, mining companies are subject to many other ‘hidden’ taxes that are less transparent and not reflected in their effective tax rate. These ‘hidden’ taxes include, for example:
• Production taxes;• Royalty severance taxes;• Employment taxes;• Customs duties;• Value-added and sales taxes; and• Property taxes.
Royalties for the extraction of non-renewable resources are promulgated across the world by governments. Some jurisdictions, such as Australia, have implemented royalty taxes based on a gross sales value of commodities rather than profit. South Africa has recently proposed such a regime and the United States has debated a royalty tax on hard-rock miners. Governments prefer gross sales-based royalty taxes because they are simple and stable.
Not surprisingly, the industry considers such ad valorem royalty taxes to be disadvantageous, since they ignore the profitability of companies and are payable even in loss-making situations. As illustrated by the US coal mining sector, a gross sales-based royalty severance tax can impede the early recovery of the capital investment required in mining, increasing the risk and therefore the cost of capital of mining projects.
The majority of these additional taxes are ‘hidden’ in operating expenses and therefore the total contribution that the mining sector makes to governments could not be quantified as part of this report. However, the Minerals Council of Australia in conjunction with PwC in their 2002/2003 Minerals Industry Survey, calculated that these additional taxes amounted to 126% of the direct tax expense in Australia.
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Financial perform
anceThe protracted debate between the mining industry and governments over tax is as certain to continue as the payment of tax itself. While governments may argue that the mining industry is receiving the lion’s share of tax breaks compared to other industries, this is rarely the case when direct taxes are combined with the ‘hidden’ tax burden.
The tax regimes of individual countries are particularly important in the determination of where to explore or where to develop. Governments that assist miners with favourable fiscal terms are far more likely to witness growth in their mining industry. In due course this leads to higher tax revenue. An interesting challenge to governments arises when a mining boom occurs. Cash-strapped governments may see short-term revenue opportunities and may take decisions that inadvertently impede long-term growth. Already, governments in New South Wales, Australia and Chile are considering new royalty regimes, which could have a damaging impact on future capital investment in these regions.
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Financial position
Financial position
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Financial position
Shareholders’ equity
The companies analysed in our study have increased their aggregate shareholders’ equity by 25% from 2002 to 2003. This increase is a result of a number of factors, including earnings reinvested in development projects, mergers and new equity issues.
Some of the notable equity raisings during 2003 were:
• Xstrata – takeover of MIM• Newmont – equity offering• Kinross – merger with Echo Bay Mines and TVX Gold
Borrowings
2003 2002
Debt to equity ratio 28.4% 30.8%
Current ratio 1.35 1.21
Quick ratio 0.89 0.80
In general, the liquidity of the industry improved in 2003. Increases in shareholders’ equity led to a reduction in the debt to equity ratio, despite the fact that the industry increased long-term borrowings by US$ 4.5 billion in 2003.
Capital expenditure
The aggregate capital expenditure of the companies analysed totalled US$ 13.7 billion, up 21% when compared to 2002.
The five companies with the largest capital spend in 2003, accounted for 60% of aggregate expenditure across the companies analysed, as shown below right.
In comparison, these same five companies accounted for 64% of capital spend in 2002.
Increasing capital investment across the industry has partly been in response to higher commodity prices and better access to market capital. The benefits of this investment will only be realised in the medium to long term due to the long-term lead times inherent in the industry. Care must be taken to ensure that increases in production do not outpace the expansion of demand. Otherwise the price increases we have seen in recent times will quickly reverse and, as we have seen so many times in the past, the new investments will deliver poor returns.
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Total Shareholder Return (TSR)
Total Shareholder Return measures the total returns to a shareholder in any given period including dividends, against the opening share price. It provides a measure of value creation.
Looking at the one-year TSR to March 2004, the five top-performing companies all have a significant base metals focus, particularly copper. The improvement in copper prices has clearly had an impact.
In contrast, the three-year TSR to March 2004 identifies companies with a gold focus as the best performers, reflecting the recovery of gold price over that period. The one exception is Companhia Vale do Rio Doce (CVRD). Freeport successfully straddled both the 1-year and 3-year TSR top performers – we note that it produces both copper and gold.
Source: Bloomberg, March 2004Note: 3-year TSR for Xstrata not available
Source: Bloomberg, March 2004
1-year TSR top performers
3-year TSR top performers
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Value
Value
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ValueValue
When investors are valuing companies, they routinely look at:
• market indicators: how much market value has improved (TSR); how volatile the share price is; and how liquid the market is;
• internal financial statistics: profit margins and revenue growth; • statistics familiar to valuation analysts: intangible value; PE ratios; and the Altman z-score, an
aggregate measure of financial health.
PricewaterhouseCoopers has developed the ValueWeb to provide a pictorial representation of these measures. For each measure, the population is standardised and a company’s quartile positioning is determined. The ValueWeb summarises, for each company, these quartile positions. The company is positioned close to the edge of the web for measures in which it scores more highly than its peers. If positioned close to the centre, it means that there is room for improvement compared to the rest of the industry.
From its ValueWeb, a company can therefore quickly identify which indicators need most attention in order to build and sustain overall value.
We have collated these indicators for all 30 companies analysed and rated them against each other. Based on this analysis, the Top 5 industry performers for 2003 are as follows:
PwC ValueWeb Top 5
1 Newmont
2 Placer Dome
3 Freeport-McMoRan
4 Newcrest
5 CVRD
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Valu
e
Newmont
Newmont’s first place ranking reflects its position as the largest gold mining company in the world, with significant reserves and a record 2003 performance. Newmont has benefited from recent increases in the gold price with its un-hedged philosophy, illustrated by having substantially eliminated its acquired Australian gold hedge books. It also strengthened its balance sheet by disposing of non-core assets and with a new equity offering in November 2003 generating over US$ 1 billion.
Placer Dome
Valu
e
22
At number 2, Placer Dome experienced significant revenue growth in 2003, which, in part, reflects increases in production through its acquisition of Aurion Gold in Australia in 2002 and the expansion of its South Deep operations in South Africa. In addition, revenues benefited from an increase in realised gold prices.
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Valu
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Health and
safety
Health and safety
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Health and
safetyHealth and safety
The global mining industry safety record has come a long way over the last 10 years, especially in South Africa, for example. The number of fatalities across major mining regions has been steadily declining over the past decade, but still remains too high. The target must be zero fatalities.
The mining industry’s response to the health and safety challenge can be seen in the decline in fatality statistics shown above. South Africa, where mines are deep and operations labour intensive, still has a much higher fatality rate than in Australia and the US but has in the last 10 years halved the total number of deaths.China has not been included in our analysis, but continues to remain a blot on the mining industry’s safety record. Over 6,000 mine workers lost their lives in China in 2003, an average of 18 mine workers per day. The fatality rate per million tons of coal produced in China during the first half of 2003 was 40,000 times higher than in the US or Australia.
Digging deeper, published in 2003, reported that company executives rated health and safety performance as very important in delivering value. In stark contrast, investors and analysts reported that they placed little importance on them as value drivers. This may account for why one third of companies we analysed did not report safety statistics in their annual reports.
With respect to international accident statistics there is limited data available for direct comparisons. There is also a delay in the reporting of aggregated national/state-wide statistics. Based on Fatality Injury Frequency Rates (FIFR – the number of fatal injuries per one million man hours worked), South Africa’s fatality record in 2002 is disproportionately high:
Australia 0.03
Canada 0.21
Chile 0.12
Mexico 0.12
South Africa 0.34
US 0.13
The mining FIFR for the US of 0.13 compares to a US national FIFR across all industries of approximately 0.08 per million man hours as reported by the US Department of Labor (2000).
The comparison of international lost time injury data is virtually impossible because of significant differences in the definition of injuries and variations in the levels of reporting. However, the industry is working in a proactive way to reporting broader outcome measures, such as Total Recordable Injuries.
In summary, whilst the industry has come a long way on safety, it still has a significant way to go and should continue rigorously pursuing improvements.
Source: National government an industry bodies statistics
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Mineral reserves
Mineral reserves
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Mineral reserves
Mineral reserves
Reserves and resources are the life blood of the mining industry. As a result, they also have a large role in determining equity market values as well as accounting profits. Indeed, much of the value of the mining industry is derived from reserves and resources that are not recorded on companies’ balance sheets.
Most of the companies analysed reported details of their proven and probable reserves. With the exception of companies listed in the US, where disclosure is restricted by the SEC, most also disclosed details of their mineral resources.
The SEC’s stance of prohibiting resource disclosure continues to be questioned by the industry. Resources have a very important role in assessing the long-term health of an organisation and for some long-life mines an amount for a substantial portion of the mines economic value. Companies listed solely in the US are therefore working at a serious disadvantage to their global peers in communicating their achievements and potential.
There is no global standard governing the classification and reporting of mineral reserves and resources. The 30 companies analysed report under the following codes:
• Canada – Canadian Institute of Mining “Standards on Mineral Resources and Mineral Reserves, Definitions and Guidelines” and National Instrument 43-101 “Standards of Disclosure for Mineral Products”
• United States – SEC Industry Guide 7• South Africa – South African Code for reporting of Mineral Resources and Mineral Reserves (SAMREC)• Australia – The Joint Ore Reserves Committee Code (JORC)
Companies have provided a relatively consistent level of quantitative disclosures with respect to estimated ore tonnages and contained metals and minerals. However, such information is inherently dependent upon a number of key assumptions, including:
• commodity prices and exchange rates;• recovery yields; and• cut-off grades.
Any one of these assumptions can significantly impact the reserve numbers reported. In practice, however, the assumptions used by companies are rarely disclosed. This severely restricts investors’ abilities to interpret the data properly and conduct their own sensitivity analyses and valuations.
This was a key finding from Digging deeper, where one third of investors surveyed did not feel companies were meeting their information requirements in this area.
Most companies report details of their current and future exploration activities, either through further expansion and development of brown-field sites or in pure grassroots or green-field exploration. However, the quality and specificity of such disclosures varied amongst the companies analysed.
The mining industry’s future profitability and value creation is intrinsically linked to its ability to both identify and recover resources economically. A great opportunity exists for companies to capture more shareholder value by increasing transparency in this area.
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Market value vs b
ook value
Market value vs book value
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Market value vs b
ook valueMarket value vs book value
Intangibles make up an increasingly large part of the market value of many industries. In some industries, this value is derived from intangible assets such as brand names or intellectual property. In the mining industry, the main sources of value include:
• Mining licences• Property rights• Mineral reserves and resources• Exploration potential
In many cases, these assets are recorded in a mining company’s accounts at a fairly nominal value. But with significant industry consolidation in recent years, a greater proportion of the value attributable to these assets has been recorded on the industry balance sheet.
Typically, the excess of acquisition cost over the net assets acquired is allocated to identifiable assets such as mineral properties and exploration projects. Only after all such assets have been valued is the remainder recognised as goodwill. So whilst recognising goodwill remains technically possible, most mining acquisitions have not led to significant amounts of goodwill. As a result there is only a limited amount of goodwill on the aggregated balance sheet, with US$ 6.0 billion in 2003 and US$ 4.7 billion in 2002.
A good indicator of the unrecognised value attributable to reserves and resources and exploration potential can be found by comparing the market capitalisation of a company to its book value.
The graph below plots market value as a multiple of book value for the 30 companies analysed. Companies with a high multiple have delivered significant value to investors, which is not reflected in the historic costs of their net assets. Companies with a multiple of less than one have a market value that is actually lower than the carrying value of their net assets. Amongst the 30 large listed companies analysed, three fall into this category.
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Hed
ging
Hedging
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Hed
gingHedging
The use of derivative instruments by the global mining industry is a relatively recent phenomenon. The complexity of these instruments can lead to some unforeseen outcomes, for example where cash calls are made to cover unrealised losses.
High-profile corporate failures across many industries have shown that some companies fail to establish proper discipline and control over the use of derivatives. There have also been deficiencies in the way of which companies communicate their hedge strategies to shareholders.
Typically, mining companies use derivative instruments to hedge commodity, currency and interest rate risk. The derivative instruments used to do this can be complex and difficult for investors (and even the companies themselves) to understand. To ensure that investors properly understand the value of the hedge strategies and positions, companies need to clarify:
• The nature of the risks they are seeking to mitigate• The strategy put in place to mitigate those risks• Whether the strategy is effective, or whether unexpected losses can occur.
Further details can be found in Hedging in the mining industry, a 2003 PricewaterhouseCoopers publication.
Industry analysis
The majority of the mining companies analysed continue to use derivatives of interest rates or currency if not for production to some extent. However, a number of companies have indicated that they intend to reduce their commodity hedge books in future years (notably Barrick and AngloGold).
Disclosure of the risks being hedged and the strategies adopted to mitigate those risks are not consistent across the industry. Companies often included generic descriptions of risks with limited information about hedging strategies applied to address them. Only a handful of companies we have analysed described their long-term hedging objectives and provided details of internal policies on the authorisation of hedging activities and hedging limits.
A good example of disclosure of hedging strategy and internal controls is provided by Inco in their annual report. They provide details of their risk management policies, the internal limits they apply and the level of review by internal committees.
Most companies apply hedge accounting to some or all of their derivative instruments. However, the application of divergent accounting practices across different reporting jurisdictions makes it very difficult to quantify the impact of derivatives on the industry’s result for 2003.
Over and above the impact of hedging on current year results is its potential impact on future results. All of the companies analysed disclosed details of the fair value of their hedge books, but twelve companies elected to do this in narrative form only. Only those companies that provided tabular summaries of the fair value of their open hedge books made it clear to investors what impact the hedge book could have on future annual results.
Even where this information is clearly disclosed, however, the values do not reflect subsequent changes in commodity prices, interest rates or exchange rates. A useful disclosure that companies do not provide, but perhaps should consider, would be the sensitivity of the company’s hedge book to changes in prices and rates.
Digging deeper highlighted that the investment community does not receive all the information it would like in relation to mining companies’ hedging strategies. Companies have an opportunity to respond to these concerns.
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Exp
loration
Exploration
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Exp
lorationExploration
We are starting to see signs of a recovery in global exploration spending. However, it is starting from a low base and it is widely acknowledged that the industry has seen a period of significant decline in the level of exploration expenditure over recent years.
The reasons for this decline have been hotly debated amongst industry participants. Larger mining companies have not seen exploration expenditure add value to their share price and have often reduced their spend. Also, smaller companies have not always been able to raise the funding to explore. To top it off, issues surrounding land access and uncertainty over whether successful exploration can be converted into production have also deterred exploration spending in some countries.
The 30 companies analysed reported an 11% increase in exploration spend from US$ 1.09 billion in 2002 to US$ 1.20 billion for 2003. In addition, the larger companies have historically encouraged juniors to undertake exploration, with a view to acquiring successful ventures. Acquisition of these entities is not captured as part of exploration spend. A better comparison of industry trends can be found in the global study of budgeted exploration spend undertaken by Metals Economics Group (MEG) of Canada. MEG reported that budgeted exploration spend had increased from US $ 1.73 billion in 2002 to US$ 2.19 billion in 2003 although a portion of the increase in exploration spend is attributable to the greater number of companies included in the survey.
Flow-through investments – a Canadian perspective
To encourage investment in speculative, resource-based ventures, the federal and provincial governments of Canada have created flow-through incentives, which allow exploration companies to transfer to their investors their rights to tax deductions for exploration. The reduction of paid income tax effectively lowers the net cost of the investment in such companies.
2003(917 companies’ budgets totalling US$ 2.9 billion)
2002(724 companies’ budgets totalling US$ 1.73 billion)
Source: Metals Economics Group
Whilst we hear much about the exploration in Russia and China, exploration spending in traditional mining regions still accounts for 85% of total exploration spend. Latin America remained the top destination in 2003, although second-place Canada’s surge has closed the gap. To a large extent, Canada’s significant increase in exploration spending is a result of the federal and provincial governments’ ‘sweetening’ of their flow-though shares arrangements, coupled with a flurry of activity in the diamonds sector. In contrast, Australia’s declining exploration spend over the past two and a half years has prompted the Australian government to commission four reports on this issue. The latest of these, the Prosser Report, recommends that flow-through shares, similar to those in Canada, should be investigated as a vehicle for stimulating exploration growth. We look forward to the Australian government’s response to the commission’s recommendations.
As always, if investment in exploration is not a priority today, there will be no industry growth in the future.
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Environm
ental provisions
Environmental provisions
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Environm
ental provisions
Environmental provisions
Mining operations exploit finite mineral resources, so by definition each operation will eventually have to close. The cost of closing down operations and cleaning up environmental damage was viewed as the cost of complying with environmental regulations. Increasingly however, the industry is accepting that these costs make a positive contribution to the environments in which they operate and are a necessary part of sustainable mining.
Our analysis shows an aggregated accumulated liability for rehabilitation and restoration costs of US$ 8.5 billion (2002 US$ 6.9 billion). The 17% increase from the prior year is partly a function of translation differences from a weaker US dollar, but is also consistent with an ever increasing focus on environmental rehabilitation by the mining industry.
Unfortunately, due to divergent accounting practices for restoration accounting, the accumulated liability does not necessarily illustrate the full costs of environmental clean-up for the companies analysed. Currently, mining companies are adopting one of three methods in relation to rehabilitation and restoration costs:
• expensing as incurred;• accrual of the estimated future rehabilitation costs over the life of the mine on an incremental basis;• provision for the present value of future costs expected to be incurred in rehabilitating past damage
(the method applied under IFRS, US GAAP and UK GAAP).
A few industry participants, particularly Latin American companies, are not recognising any liabilities in relation to environmental rehabilitation and restoration. In addition, whilst some companies recognise both constructive environmental obligations, some only account for legal obligations.
Of the companies analysed, 7% did not disclose their accounting policies with respect to rehabilitation costs. These companies were domiciled in Latin America. 24% of companies adopted the incremental method and 69% adopted the discounted present value approach. In Canada, the discounted present value basis becomes compulsory for all financial years commencing after 1 January 2004. However, nearly half of the Canadian companies analysed have elected to early adopt the method in 2003. Australia will also move to the discounted present value method in 2005 under its IFRS convergence programme.
Inevitably there is some uncertainty about the reliability of cost estimates for rehabilitation costs that will not be incurred for many years. These estimates are dependent on a number of assumptions and are expected to change over time because of factors such as:
• changes in life of mine plans;• improvements in technology;• changes in legislation; and• changes in long-term inflation and discount rates.
Surprisingly, assumptions are rarely disclosed amongst the companies surveyed and this lack of transparency limits the usefulness of the information disclosed.
This is supported by the research conducted for Digging deeper, which identified an information gap of 55% between the value placed on information surrounding environmental liabilities to investors and the adequacy of the information being provided to them.
Also, whilst some companies now use third party consultants to examine their cost estimates, this is by no means the norm.
An opportunity exists for companies to meet this reporting challenge by increasing the quality and relevance of the information they provide to investors about environmental obligations.
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Directors
Directors
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Directors
The theme of improved corporate governance runs through many of the annual reports analysed, both through the publication of expanded corporate governance statements and as a component of the Chairman or President’s report.
Companies are keen to demonstrate that they are adopting corporate governance best practices, and are providing more background information on directors as well as details of the composition and meetings of the Board and its sub-committees.
The contribution from non-executive directors is also being bolstered. They now account for the majority of the Board in most of the companies analysed with an average ratio of 3:1 between non-executive directors and executive directors. A number of companies have also taken steps to strengthen the independence of non-executive directors by ensuring they have no direct involvement in the day-to-day operations of the company or stock options.
The audit committees of the companies analysed are all made up exclusively of non-executive directors. This level of independence has become established as best practice around the world.
CEO remuneration
South American companies do not generally disclose the remuneration of their executives. CEO remuneration of the other mining companies analysed ranged from US$ 0.5 million to US$ 8.5 million. Excluding severance bonuses, it totalled US$ 49 million in 2003, an increase of US$ 16 million or 48% over 2002.
Corporate governance
We have analysed in the graph to the right CEO remuneration relative to the size of the company as measured by market capitalisation. The majority of CEOs are remunerated between US$ 100 000 to US$ 400 000 per US$ 1 billion market capitalisation.
The chart to the right compares the annual growth in CEO remuneration to the company’s Total Shareholder Return (TSR) in 2003. This shows that CEOs’ remuneration increased by less than the TSR for 65% of the companies analysed, and for 18% of the companies, the CEOs’ remuneration increased by more than double the TSR.
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Sustainab
ility
Sustainability
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Sustainab
ilitySustainability
Corporate sustainability requires open and meaningful reporting of the ‘triple bottom line’, comprising economic activity, environmental activity and social concerns. The benefits to local stakeholders from sustainable mining are clear. The debate continues as to whether investors also benefit. With the growth in social funds and social indices, many now believe that a company’s share price will suffer if it focuses too heavily on its financial results – to the exclusion of social and environmental issues. There is also a clear risk that a poor social/environmental performance could create unrest and, in the longer term, threaten a company’s ability to operate.
Twenty of the thirty companies analysed prepared separate sustainability reports for 2003. The most notable exceptions were companies located in North and South America, although most of these companies all provided some information about their social and environmental performance within the Annual Report.Some companies include a third party opinion within their sustainability reports to provide assurance that the data has been verified. However, this is still very much the exception rather than the norm. Also, there is no internationally recognised standard for reporting on such data, and in some cases it is difficult for a reader to understand how much assurance is actually being given.
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Political risk
Political risk
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Political risk
Political risk
In an industry where the redeployment of assets is not practicable and investment is long-term in nature, the impact of political risk can be enormous.
The Fraser Institute, an independent Canadian research organisation, conducts an annual survey of mining companies to assess how public policy factors affect exploration investment. They prepare a Policy Potential Index, which is a report card on the attractiveness of governments’ mining policies. The Index takes into account factors such as existing regulations, environmental regulations, taxation, native title land claims, infrastructure, socioeconomic agreements, political stability and labour issues.
Against this background, it is not surprising that the level of new mining investment in countries such as Indonesia has declined significantly.
The laws and policies on land rights and tenure vary from country to country. However, there has been a clear trend towards increasing the rights of indigenous peoples.
In Australia, the Native Title Act was introduced following the landmark Mabo court judgement in 1992. In South Africa, the government has introduced the South African Mining Charter. It lays down certain social and sustainable development criteria. In addition, it requires each mining company to ensure 15% Black Economic Empowerment (BEE) ownership of their assets within five years, and 26% BEE ownership within 10 years.
Digging deeper identified political risk as one of the main indicators for which investors are dissatisfied with the information disclosed by mining companies. In 2003, less than half of those companies we have analysed referred to the impact of political risk in their annual reports. Of these, most only made a brief mention in either the Chairman’s report or Management’s Discussion and Analysis – with no assessment of how management are addressing the risks identified. South African companies generally disclose the most information on political risk, with Harmony Gold’s annual report standing out as a good example.
Excerpt from the Policy Potential Index
Source: Fraser Institute, 2003
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Companies analysed
Company1 Country Year end
Anglo American plc United Kingdom 31 Dec 03
AngloGold Limited South Africa 31 Dec 03
Anglo American Platinum Corporation South Africa 31 Dec 03
Antofogasta plc United Kingdom 31 Dec 03
Barrick Gold Corporation Canada 31 Dec 03
BHP Billiton Group2 Australia 30 Jun 03
Cameco Corporation Canada 31 Dec 03
Cia de Minas Buenventura Inc Peru 31 Dec 03
Companhia Vale do Rio Doce Brazil 31 Dec 03
Consol Energy Corp United States 31 Dec 03
Falconbridge Canada 31 Dec 03
Freeport-McMoRan Copper & Gold Inc. United States 31 Dec 03
Glamis Gold Limited Canada 31 Dec 03
Gold Fields Limited South Africa 30 Jun 03
Grupo México, S.A. de C.V. Mexico 31 Dec 03
Harmony Gold Mining Company Limited South Africa 31 Jun 03
Impala Platinum Holdings Limited South Africa 31 Dec 03
Inco Limited Canada 31 Dec 03
Kinross Gold Corporation Canada 31 Dec 03
Lonmin Plc United Kingdom 30 Sep 03
Newcrest Mining Limited Australia 30 Jun 03
Newmont Mining Corporation United States 31 Dec 03
Noranda Inc. Canada 31 Dec 03
Peabody Energy Corporation United States 31 Dec 03
Phelps Dodge Corporation United States 31 Dec 03
Placer Dome Inc. Canada 31 Dec 03
Rio Tinto Group2 United Kingdom 31 Dec 03
Teck Cominco Limited Canada 31 Dec 03
WMC Resources Limited Australia 31 Dec 03
Xstrata plc United Kingdom 31 Dec 03
1 State-owned mining operations have been excluded from our analysis. We have also excluded companies in the metals refining and processing industry.2 Dual-listed entity
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Current ratio Current assets
Current liabilities
Debt to equity ratio Borrowings
Borrowings plus shareholders’ funds
EBITDA Earnings before interest, tax, depreciation and amortization. A measure that is close to the underlying cash earning stream of the company before servicing the capital base.
EBITDA margin EBITDA
Total revenues
IFRS International Financial Reporting Standards
Market capitalisation The market value of the equity of a company, calculated as the share price multiplied by the number of shares outstanding.
Net profit margin Net profit
Total revenues
P/E ratio Price earnings ratio. The price of a share divided by the annual earnings attributable to each share.
Quick ratio Cash plus accounts receivable plus other financial assets
Current liabilities
Return on capital employed Net profit
Property plant and equipment plus current assets less current liabilities(average of opening and closing balances)
Return on equity Net profit
Shareholders’ equity(average of opening and closing balances)
TSR Total shareholder return as measured by dividends and capital gain during the period over the opening share price. Comparable to investment fund performance in any given year.
Glossary
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PricewaterhouseCoopers
Global Mining Group Leadership Team:
South Africa and GlobalHugh Cameron, JohannesburgTelephone +27 (11) 797 4292E-mail: [email protected]
Asia-Pacific Tim Goldsmith, MelbourneTelephone: +61 (3) 8603 2016E-Mail: [email protected]
CanadaPaul Murphy, TorontoTelephone +1 (416) 941 8242E-mail: [email protected]
South AmericaAnthony Dawes, SantiagoTelephone +56 (2) 940 0064E-mail: [email protected]
United KingdomBrian Taylor, LondonTelephone +44 (20) 7213 2518E-mail: [email protected]
United StatesSteve Ralbovsky, PhoenixTelephone +1 (602) 364 8193E-mail: [email protected]
For copies of the report, please contact:Rashree MaharajGlobal Marketing Manager – Mining2 Eglin Road, Sunninghill,Johannesburg, South AfricaTelephone: +27 (11) 797 5663E-mail: [email protected] visit our website: www.pwc.com/mining
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Key contributors to the survey:
Tim Goldsmith – AustraliaDebbie Smith – AustraliaMichael Cinnamond – CanadaOrlando Marchesi – PeruIan Campbell – South AfricaBrian Taylor – United KingdomMichael Ruyter – United States
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