A report by US investment bank Citi found that the world's largest mining groups have written off about 90% of the value of mergers and acquisitions completed since 2007, as reported in Fairfax media this morning.
Or to put it in more sobering terms, acquisitions made since 2007 are now worth roughly 10% of their purchase value.
Rio Tinto Limited (ASX: RIO) was found to be the worst off, with 34% of its asset base impaired. In a simplified sense, impairment happens when the 'recoverable value' (market value) of an asset drops below the price paid for it.
For instance if iron ore prices fall substantially, iron mines become less valuable because they make less profit. If a company bought the mine when ore prices were higher, the market value of the mine will drop below the price paid for it; this fall must be recorded as an impairment and will count against profit in that financial year.
Rio Tinto has a staggering 34% of its assets impaired, which Citi argues indicates poor capital allocation over the past eight years – weak commodity prices notwithstanding.
The biggest cock-up was undoubtedly the Alcan acquisition, but each year brings further impairments from the mining giant – another $1.1 billion was impaired just last year on the group's molybdenum assets.
Do impaired assets REALLY indicate poor returns to shareholders?
The truth is that Rio has grown underlying earnings by roughly 3% per annum (compounded) every year since 2007. Total cash flow in 2014 was some 13% higher than was recorded in 2007, despite the fact that iron ore prices in 2014 were substantially lower than in 2007.
Rio shares have fallen 43% since 2007, compared with the S&P/ASX 200 (INDEXASX: XJO) return of negative 11%. BHP Billiton Limited (ASX: BHP) shareholders lost 19% of the stock's value since 2007, while Fortescue Metals Group Limited (ASX: FMG) shareholders are down 42%.
By way of comparison, blue-chips Commonwealth Bank of Australia (ASX: CBA) and Woolworths Limited (ASX: WOW) are up 57% and down 3% respectively. In the absence of a once-in-a-lifetime commodity boom, miners aren't great vehicles for growing wealth over the long term. Even more concerning is the fact that Citi expects the impairment bill to keep rising, particularly in the iron ore and coal sectors. Investors beware.
In the absence of a once-in-a-lifetime commodity boom, miners aren't great vehicles for growing wealth over the long term. Even more concerning is the fact that Citi expects the impairment bill to keep rising, particularly in the iron ore and coal sectors. Investors beware.
