Several major mining companies, laden with acquisition-related debt, flirted with disaster in the financial crisis. Thanks to China, commodity prices rebounded and share prices recovered. The miners reduced debt and have now stepped up spending on big new projects. But growing project risk is working against much more of a sector rerating.
Anglo American's yearly capital spending is running at around $4 billion and Xstrata's nearly $5 billion, around 10% of their market value. Rio Tinto will spend $9 billion in 2011. Yet investors appear to be attributing little extra value to future output from green field projects—at least until they are completed.
Mining sector shares, despite the rally in the past year, are still trading at seven times to eight times forecast earnings compared with historic double-digit multiples. And most mining stocks have some catching up to with commodity prices. Although the FTSE mining index is up 32% in the past year, it's still down 4.6% from August 2008. The Economist's metals index has risen 18% since then.
To see why, look at Anglo American. The first of three phases at its most important growth project, Minas Rio in Brazil acquired for $6.7 billion in 2008, is at least a year late. It will cost more than $4.5 billion against an initial budget of $2.7 billion. If things continue to go wrong, Anglo may destroy shareholder value.
Anglo's challenge isn't unique. Many big undeveloped ore deposits are in inaccessible parts of the world, such as the Andes, Mongolia, and West and Central Africa. As well as mines, companies increasingly have to develop infrastructure like pipelines and ports. BP's Gulf of Mexico accident has heightened growing awareness of the environmental impact of resource extraction. Anglo is struggling to get the permits it needs in Brazil.
True, there are exceptions, such as BHP Billiton, armed with the biggest lowest-risk projects, and Antofagasta, exposed to copper's strong supply-demand outlook. But the miners' profits are also tempting targets for cash-strapped governments as the Australian super-tax furor showed. And the boom in exchange-traded commodity funds has given investors an alternative to holding physical metal or sharing the miners' operational risks.
Until the economic outlook brightens, investors may resist the capital-spending bait.‹
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