How would you feel if over the past 5 years the value of you house decreased by 50% and the value of your stock investments were down 30% and unlikely to recover? To make matters worse, your boss has also cut your pay by 50%.
Welcome to the tragic recent past of our giant miners. Over the past 5 years, BHP Billiton Limited's (ASX: BHP) market capitalisation has shrunk by more than 50% and its 2011 investments in shale oil assets have been written down by 30% on two occasions so far. At the same time, the crash in commodity prices has slashed the revenue flowing to the company by more than 50% for each unit it produces. Although I must admit that the recent demerger of South32 Ltd (ASX: S32) did play a part in the market cap falling.
BHP isn't alone. Rio Tinto Limited (ASX: RIO) and Newcrest Mining Limited (ASX: NCM) have suffered from the same problems. Iron ore producer Fortescue Metals Group Limited (ASX: FMG) hasn't made the disastrous acquisitions that the other three have but it carries a higher level of debt which is also a risk as the price of iron ore continues to slide.
Together, these 4 companies account for around 65% of the market capitalisation of the 700 or so mining companies listed on the ASX.
At a time of falling commodity prices, these giants are ramping up production. The latest results from these companies generally showed record levels of production across most commodities.
With world class, low-cost assets the increase in production against falling commodity prices does make some sense. As additional tonnes are produced from existing infrastructure the overall cost per unit will continue to decrease which is bad news for higher-cost mining companies.
BHP Billiton
BHP is the world's largest mining company and recently demerged South32 Ltd (ASX: S32) in keeping with its strategy "to own and operate large, long-life, low-cost, expandable, upstream assets diversified by commodity, geography and market". If you want to know more about South32, this article has a good summary.
BHP now remains with its "four pillars" – iron ore, coal, copper and petroleum. The diagram below shows that all assets are in the lowest 50% of the global cost curve and that all assets have exceptional operating margins above 50%, excluding coal.
BHP's US$20 billion purchase of oil and gas assets in 2011 has not been friendly for shareholders. These assets have already been written down by US$5.5 billion and with declining oil and gas prices it is possible there will be more pain in the future.
Rio Tinto
Rio Tinto is a diversified mining company and has world class, low-cost operations in coal, copper, diamonds and other minerals. But iron ore still represents the lion's share of earnings.
After years of expansion throughout its Pilbara iron ore assets, Rio Tinto will export more than 300 million tonnes of iron ore this year and the business is highly leveraged to this single commodity. In fact, during the 2014 financial year, iron ore accounted for more than 80% of group profit.
The aluminium business is the next major contributor after iron ore but has a chequered past. Rio Tinto paid $38 billion for the assets of Canadian aluminium producer Alcan in 2007. Fast forward to today and the company has written down around 75% of the value of this purchase.
Newcrest Mining
Newcrest Australia's largest gold miner and the sixth largest in the world. It has low-cost operations spanning Australia, Papua New Guinea, Indonesia and West Africa. The 2015 financial year results showed all-in sustaining costs of US$762 and average realised gold price of US$1,193 – a margin of 56% on every ounce produced.
However, high margin gold mines haven't helped the company avoid impairments. Newcrest took over Lihir Gold in 2010 at a cost of around $10 billion and subsequently wrote down the value of this asset by $3.5 billion in 2013 and then again by $2.7 billion in 2014. The Lihir impairments accounted for 65% of a total $9.5 billion wiped from Newcrest Mining's asset base in 2013 and 2014.
Fortescue Metals Group
Since its formation in 2003, Fortescue has evolved from an exploration company into the world's fourth largest producer of iron ore that now exports 165 million tonnes of iron ore out of the Pilbara each year. As a pure iron ore play, it is fully exposed to the price of this commodity.
Fortescue has been busy cutting costs and has a stated breakeven price of US$39/tonne and is aiming for around US$34/tonne by the end of FY2016. Rio Tinto and BHP have estimated breakeven costs of below US$30/tonne which Fortescue will unlikely ever match due to the higher cost Chichester Hub mines – Cloudbreak and Christmas Creek.
The business carries a hefty US$9.3 billion of debt and recently refinanced US$2.3 billion during tough market conditions at a rate of 9.75% per annum. No debt repayments are due until 2019 when the company will have to pay US$4.9 billion to debtholders.
Summary
The recent history of BHP, Rio Tinto and Newcrest making value-destroying acquisitions should keep the current management teams focused on improving the performance and profitability of their current assets rather than expanding by acquisition.
BHP, Rio Tinto, Newcrest and Fortescue own and operate assets which are among the lowest-cost in the world and should continue to make a profit even in the current market. Investors buying into these companies will be rewarded if commodity prices increase, but global demand and prices for commodities are near-impossible to predict.
The investment risk versus the potential reward is currently too high to give me comfort. I will wait and see if these global giants can perform and deliver on their targets during this period of low prices before considering an investment in any of them.
