Glencore and Rio Tinto fuel commodities outlook discussion
Glencore’s Ivan Glasenberg joined his collegue at Noble group and Rio Tinto’s CEO Tom Albanese in stressing that there are no clear signs of a slowdown of Chinese commodities demand.
Glasenberg stressed that inventory levels for many commodities are relatively low at the moment, contrary to the belief that increasing inventories should cause a drop of commodity prices somewhere in the next year.
BHP Billiton rumoured to prepare bid for coal miner
BHP Billiton is rumoured to prepare a bid for Walter Energy, a metallurgical coal producer with operations in the USA and Canada, and a project in Wales.
Current market capitalization of Walter (WLT) is around $3.8bln, down roughly 50% from a year ago.
A potential new takeover by BHP Billiton might be a good moment for BHP to announce writedowns on its acquisitions in the natural gas space. The acquisition of Petrohawk from Chesapeake last year is said to require a significant writedow as gas prices don’t seem to recover. Timing the market and combining the ‘exciting’ news of a takeover in the coal industry might partly overshadow the news of the writedown on the gas assets.
The decrease of annual growth of the Chinese economy to single digit numbers is expected to impact construction and manufacturing activity in the short term, but the underlying outlook for the longer term continues to be a shortage of supply. Experts struggle to relate the overall economic growth numbers to short-term growth of construction sector, which drives most of the commodities demand.
In the re-election of Xstrata’s directors the vote against re-election of Ivan Glasenberg, the head of Glencore, increased from 3.6% last year to 13.6% this week.
When voting on Glencore’s takeover offer for Xstrata a group of approx. 17% of shareholders could block the deal as 75% of shareholders excluding Glencore’s 33% needs to support the deal.
Mr. Glasenberg indicated most of the debate on the merger currently is about the share ratio, which Glencore currently offering 2.8 shares per share of Xstrata.
BHP Billiton and Rio Tinto return cash rather than invest more
Both BHP Billiton and Rio Tinto stressed their commitment to dividend and buyback policies this week.
Though reiterating the sustained belief in the long-term growth fundamentals of the commodities markets, the focus of the messages in investor presentations is shifting towards limiting and phasing investment, rather than growing as fast as possible.
Miners currently focus on returning cash to shareholders because of the combination of short-term cost pressures that make margins shrink and longer term uncertainty about the pace of growth of global demand and the direction of metal prices. Citigroup’s forecast of a falling overall capex (see below in FT’s picture) shows uncertainty about how many of the projects in the current pipeline are really going to make it. Investments in star projects are still done, but the projects that could turn out to be marginal or lossgiving are on hold.
Mr. Glasenberg’s comments about the share ratio discussion appear to indicate that Glencore’s bid for Xstrata might be sweetened if the deal runs the risk of not being accepted in Xstrata’s shareholder meeting early July.
April is traditionally the month in which the major diversified miners present their annual results. BHP Billiton closes its fiscal year in the mid of the calender year, but joins its main competitors in giving an update of its performance in an investor meeting in this month. One of the key objectives of the executives presenting their numbers to an audience that will listen to each of the presentations in the course of a couple of weeks is to make the company look good, or at least better than competitors.
Managing the expectations of investors serves a twofold purpose: in the first place the goal is to make sure the investors know what they are investing in and what the perspectives for the company are – as a result the stock price should reflect the true performance and potential of the company; in the second place the goal is to keep the shareprice high or make it go higher – often referred to ironically as ‘reflecting the true value of the company’.
Why care about stock prices?
Market value matters in the first place from a financial point of view. The higher the market price, the easier and cheaper it is to raise debt, giving flexibility to invest.
The second important reason to care about the share price is the mergers and acquisitions arena. An undervalued company is an acquisition target, and having a strong share price makes doing paper acquisitions (pay with shares instead of cash) attractive.
Why not care about stock prices?
Market value does not matter because an executive should not be driven by short term stock price fluctuations, which are typically mainly the result of market conditions and events the executives do not have a hand or a say in. In the long term good management will lead to a distinct outperformance of competitors, but short term movements are too erratic to say much about management performance.
An executive should not be driven by the market price (i.e. the shareholders interest) alone, but should take the interests of other stakeholders (employees, society), which are often not directly or fully included in the share price, in account too.
Chalco (holding company = Chinalco) made a tentative $930mln offer for 57.4% ownership of SouthGobi Resources, a Canadian listed company, currently owned by Ivanhoe resources.
BMA, the coal JV between Mitsubishi and BHP Billiton in Queensland, declared force majeure after a week long strike in some of its mines. The labor conflict has been going on for almost a year, with workers campaigning for better contract rights for contracted workers and to retain the union’s power in recruiting decisions.
Alcoa, the largest aluminium producer in North America, announced it would cut alumina production by 2% to support prices.
At the start of the year Alcoa cut aluminum production, at that time by 12% and mainly in the USA. The 2% alumina cut is said to be aligned with this 12% ‘final product’ cut.
The potential Chalco – SouthGobi deal appears to be engineered by or via Rio Tinto. Chinalco owns a significant stake of Rio Tinto, which became the majority shareholder of Ivanhoe recently with the key objective of quickly developing the Oyu Tolgoi gold-copper mine (also in Mongolia).
Despite a general demand boom which has not passed aluminum many major aluminum producers are posting losses. Profit margins over the past 10 years average below 10%. The key reason for this situation is an overcapacity resulting in oversupply and high inventory levels. Aluminium is currently one of the very few mined natural resources that could be seen as a ‘demand-driven’ market rather than a ‘supply-driven’ market for price setting. However, as more and more producers cut investment, the demand growth fundamentals should invert this situation in the next couple of years.
Alcoa's long term demand outlook as presented end of 2011
Rio Tinto started a ‘strategic review’ of its diamond business to explore divestment options for the 4 assets. The move comes only months after BHP Billiton announced it intends to sell its only diamond project.
Rio Tinto was seen as the most likely buyer of BHP’s Ekati project because of the close proximity to it’s Diavik operation.
BHP Billiton iron ore president quits; replaced by insider
Ian Ashby, president of BHP Billiton’s iron ore division, announced he will step down in July. BHP will replace him with the head of the energy coal business: Jimmy Wilson.
The leadership change comes during an aggressive investment program to expand capacity of the Pilbara operations.
A leaked government report states that the Indian government missed out on $210bln by selling state owned coal assets to cheaply without having a proper auctioning mechanism in place.
The hedge fund TCI, which owns close to 2% of Coal India, has started a process to sue the management of Coal India for allowing too much government interference related to the sale of assets.
In March of last year Rio Tinto was said to explore a partnership with Alrosa, the world’s second largest diamond miner. This cooperation never materialized, and it appears Rio Tinto’s management has decided the iron ore business does not fit in its strategy of running large scale operations of traded minerals. With the presence of DeBeers and Alrosa it is unlikely that a third player will be able to invest to buy both Rio Tinto’s and BHP Billiton’s operations.
India is one of the few mineral rich countries in the world that had to go through a large scale privatization program in the last years. Typically domestic investors who know the businesses and have access to influential officials manage to get good deals in buying assets (Russia is another good example). Often the real value of the formerly government owned assets only becomes apparent after a couple of years of operation in private hands.
Rio Tinto invests over $0.5bln on driverless trains
Rio Tinto announced a large investment in its ‘Mine of the Future’ program to make the first of its approx. 150 trains on the Pilbara iron ore network driverless by 2014. The program will cost the company over $500mln, though it remains unclear what part of that amount is ‘research’ and what part is plain ‘hardware’.
Kazakhmys, the Kazakh copper miner, posted flat profits as growth was offset by cost increase of over 20%, mainly due to skyrocketing labour costs in the country’s resource market. The company also made bullish statements about growth of the copper demand in China.
Driverless trains are only one step in the larger automation effort for which Rio Tinto is the technology leader. Other areas of research are improving exploration performance and increasing recovery, especially from underground mines. A lot of the automation work focuses on the iron ore operations in Northern Australia. These operations have the scale to enable large savings by automation, and they struggle continuously with finding sufficient skilled employees at acceptable costs.
Whether or not Rio Tinto’s role as the ‘technology leader‘ is a smart strategy is debatable: one might argue that begin a ‘smart follower‘, and thus not paying for the disappointments any large-scale research program holds, is more cost-effective. However, Rio Tinto has taken the approach that any research that can pay for itself in the long term is worth doing. Clearly the company will try to protect its findings as much as possible, but other companies will certainly start using its innovations in some way, reducing demand for skilled labor in remote positions and improving recovery potential.
Conflict arose in the board of Bumi, the Indonesian coal miner with the investor Nathan Rothschild as a large investor after a reverse takeover of the Vallar investment vehicle. After initial conflicts the Indonesian board members planned to remove mr. Rothschild from the board, but he now only appears to have to give up his co-chairmanship. Share price of the company dropped significantly after the news of the conflict.
(Higher prices + higher costs) x lower volumes = lower profits. That was the story of the results releases of the world’s largest miners this week. The impairment taken by Rio Tinto on the Alcan acquisition costs probably was the most significant item, together with the relatively positive outlook given after the negative and uncertain signals given about global demand in the past months.
BHP (58%) and Rio (30%) expand Escondida at $4.5bln cost
BHP Billiton and Rio Tinto announced investments of $4.5bln to replace the plant at Escondida, the world’s largest copper mine in output, increasing capacity and enabling mining restricted by the current facilities.
February is the month in which most of the world’s largest diversified miners present their annual results (only BHP Billiton runs a different fiscal year). The investor presentations provide interesting reading and give a good idea of the vision for the future of the industry. Below a peak preview with the most insightful slides from the presentations:
Anglo American – Price benefit achieved mainly in first half of year
Rio Tinto – 2011 in Summary: high prices are the only good news
BHP Billiton – Cost pressure is high, but not structural
Rio Tinto – Borrowing to pay out next to all investments
Anglo American – restarting the diversification discussion
Xstrata – Supply constraints lead to the Glencore merger
Vale announced its plans to appeal to the governments intent to charge $5.6bln worth of taxes on foreign earnings. The clash with the government promises to be the first real test for the new CEO Murilo Ferreira.
Mr. Ferreira took over the leadership of the company from Roger Agnelli, who was not reelected partly based on a disagreement with the government (which is control Vale via state-controlled shareholders) over $2bln taxation.
Rio Tinto increased its ownership of Ivanhoe from 49% to 51%, giving it full control over the flagship Oyu Tolgoi copper project in Mongolia, the world’s premier copper development project.
Vale estimates the impact of a review of the tax code on the company’s earnings to be approx. 4-5% of earnings. Taxation regimes around the world for specifically iron ore and copper mining are reviewed to make the countries benefit more from ‘extreme’ profits, which could be seen as a temporary phenomenon. However, the key issue in Vale is facing now is a debate about double taxation; paying taxes over profits after taxes realized in countries where the company is operating.
Rio Tinto’s control over Ivanhoe will help the company to put in place its management structure and have the project managed by some of its top project developers. Gaining full control of the project in this stage will help Rio Tinto to build the project according to the company’s standards, preventing costly and above all time-consuming future transitions in the operating structure. The global standards that enable effective project management more and more set the world’s largest miners apart from the ‘small’ mining firms with only a few operating assets. Very much like GE has become known as a great ‘project management company’, the world’s largest miners are more and more developing into ‘mine development’ companies in which development speed is the key success factor and navigating politics in developing countries is a key skill.
BHP Billiton and Rio Tinto deliver record production in Pilbara
This was another record-breaking year in the Pilbara with both quarterly and full year iron ore production. Record global iron ore shipments of 239 million tonnes in 2011 were below production due to extreme weather conditions experienced in the first half of the year. Despite this, Rio Tinto’s Pilbara ports operated at above annualised capacity rates and shipped record volumes of 61 million tonnes in the fourth quarter and 225 million tonnes for the full year.
While scheduled maintenance, tie-in activities and the wet season in the Pilbara are expected to affect Western Australia Iron Ore production in the second half of the 2012 financial year, full year production is now forecast to marginally exceed prior guidance of 159 million tonnes per annum.
Vale proposed a minimum dividend of $6bln for the year, an increase of over 50% versus the previous year’s minimum payment and in line with the actual dividend payment over 2011.
Rio Tinto and BHP Billiton continue to build capacity in the Pibara iron ore district. With relatively low mining costs and close proximity to the Asian/Chinese market this iron ore region is the most competitive (and largest) producer in the world. As the output in Pilbara is exceeding expectations and Chinese growth is slowing, exporters in other regions face an uncertain future. The global iron ore market is slowly evolving to a scenario where Brazil and Western Africa supply ore for the European market and the Latin American growth market, and Australia supplies iron ore for Asia.
Vale’s increase of dividends fits in the trend of recent dividend increases in the industry and is a clear sign of uncertainty in the boardrooms of many companies: organic investment opportunities and development capacity are limited, share buybacks and cash takeovers would increase leverage and vulnerability, and with the uncertainty about future economic developments many companies decide to give the cash to shareholders in an attempt to keep share price high.
After 5 years as CFO of the world’s largest miner Alex Vanselow (Brazilian national) announced he will step down and look for a CEO position in the industry. Mr. Vanselow managed to get BHP through the economic downturn in great financial shape (helped by high commodity prices). His recent experience in acquisitions of Chesapeake assets and Petrohawk and the failed acquisitions of Rio Tinto, Potashcorp, and the failed Pilbara JV with Rio Tinto, make him an interesting candidate for any resources company looking to grow by M&A.
In a legal fight over the rights to the Anglo American Sur project Anglo’s lawyers blame Codelco and the Chilean government to act unfairly. Codelco holds an option to buy 49% of the project, but it is unclear whether that is only of Anglo’s stake or of the total project.
BHP Billiton announced it will review its options around its only diamond project: Ekati diamond mine in arctic Canada. Rio Tinto, which owns the nearby Diavik diamond mine, is the most likely buyer because of the synergistic potential and the lack of funds and abundance of capital spending needs of other large diamond miners.
Mr. Vanselow will be an interesting candidate for global companies looking for a change of CEO. As Brazil’s Vale recently changed CEO and Petrobras’ Gabrielli de Azevedo is widely recognized as a strong CEO with work to do he will most likely look to head up a foreign player. The ideal period for a CEO is typically seen as 6-8 years: after that a new point of view and a new alignment with the personality needed for the phase of a company is often helpful. Taking a look at the top positions of the world’s largest miners at this moment, several CEO position changes can be expected over the coming years.
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