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Longer-term fundamentals look compelling for miners

Wednesday 19th May 2010
A fundamental shift from debt to equity in the global mining and metals industries has been highlighted by Lee Downham, head of mining and metals, UK & Ireland, at Ernst & Young.

Speaking at the Mining World Congress in London, Downham said: "The global mining and metals industries were severely afflicted by the financial problems that emerged during 2008 and continued through 2009.

"The collapse in commodity prices directly impacted profitability, which in turn forced the mining sector to cut back on development expenditure with a loss to the global economy of perhaps two years of normal supply."

His comments come on the back of a new report by Ernst & Young launched at the conference, Life After Debt, which examines the industry’s dramatic response to the wall of debt and observed a drastic reduction in net debt and record levels of equity issuance.

As balance sheets strengthened in 2009 on the back of returning cash flow, so the trend in net debt was dramatically reversed, according to the Ernst & Young report. With the focus on repaying and refinancing existing borrowing, debt was reduced to record levels - the wall of debt came crashing down, replaced by a surge in equity raisings.

Downham said: "Equity issuance by our sample reached a record US $36billion in 2009. In real terms equity issued by our sample was more than double the level of any prior period back to 1980 when our analysis began.

"Record levels of refinancing, coupled with record levels of corporate bond issuance, pushing the maturity of debt out significantly, resulted in an astonishing level of debt reduction across our sample. Financial gearing came down by a full 20 percentage points, back to historical norms. The sector is now in a significantly stronger financial position."

The dramatic reduction in borrowing was a trend reflected across the whole mining and metals industry. The level of borrowing in the industry fell by 64% year-on-year, to US $62.4billion in 2009 compared to US $172billion in 2008 with loans difficult and costly to secure.

Downham said: "The act of arranging loans became more difficult to achieve, and the cost of borrowing soared, with high spreads even for investment-grade borrowers. Significantly, an astonishing 58% of loan proceeds in 2009 were used for the refinancing of existing debt."

Equity raising reached records levels in 2009, as the majors raised huge amounts to pay down their debt, and the juniors raised small amounts, but in their droves, to fund their survival.

Downham said: "Emergency rights issues and large share placings by the majors dominated the financing landscape, with London hosting the highest share by value in 2009, raising US $24.9billion. At the other end of the scale, low value issues by junior explorers dominated equity raising in Toronto, accounting for half of all proceeds raised in the market.

"Efforts to reduce debt and strengthen balance sheets came at the expense of capital expenditure though. Total capex by our sample declined by 30% in 2009 compared to 2008 levels. This drastic reduction of capex is likely to have a lasting and significant impact on supply."

Debt played an increasingly important role in the acquisition spree of 2006-2008, fuelling consolidation, the likes of which we may never see again. We have already witnessed the early impact of the debt constraint on deal activity in the sector during 2009, with just a third to the number of mega deals (US $1billion-plus) seen at the height of the acquisition spree in 2007.

Almost unanimously, analysts are predicting stronger forward curves and a return to robust earnings, possibly to levels previously seen at the peak of the most recent cycle in 2007. Despite this positive outlook, there seems no imminent return to the leveraged mergers and acquisitions experienced in 2006-2007, and capital allocation remains a major threat to short term supply.

Downham said: "Clearly it takes two to tango. While there may be a desire from the mining sector to transact and to raise funds for capital development, securing debt finance on terms sufficiently attractive to justify the borrowing remains difficult. Project finance has been near impossible to secure and the chances of financing a mega-deal purely through debt appear non-existent.

"Capital allocation remains a fundamental risk for the mining and metals industry. Until we see a significant loosening of the credit markets, innovation will remain the key to successful transactions and capital development alike."

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Mike Jones

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