The global mining complex continues to do the right thing and transition away from a strategy that privileged growth for growth’s sake, often without consideration for the underlying costs.
If the industry continues to reduce capital expenditures at the current run rate, annual spending on growth projects could fall from $111 billion in 2014 to less than $70 billion over the next four years.
Mining companies continue to do what they can to right-size their businesses and address the oversupply, but China’s appetite for these vital resources remains the key driver on the demand side. The Mainland continues to account for a significant portion of global consumption, and the country’s economic slowdown has reduced demand for a wide range of commodities.
Cost inflation has challenged the mining industry over the past decade and usually outpaces the rate of price increases in the overall economy. Despite falling commodity prices, mining concerns faced the second-highest rate of cost inflation in a decade—a major headwind.
This inflationary trend has offset the big mining companies’ aggressive efforts to cut costs and the salutary effects of recent weakness in the Australian dollar and the currencies of other resource-rich nations.
Given the challenges that the mining industry faces, dividends are in danger. The risk of a payout cut is highest when you venture beyond major, diversified miners such as Rio Tinto (LSE: RIO, ASX: RIO, NYSE: RIO), Glencore (LSE: GLEN, OTC: GLNCY) and BHP Billiton (ASX: BHP, NYSE: BHP).
Against this backdrop, management teams continue to slash capital expenditures aggressively and have redoubled their efforts to cut production costs to the bone. Over the intermediate term, these self-help measures will reduce supply, a development that would set the stage for some improvement in commodity prices.
Value-oriented investors interested in the mining space should focus exclusively on the best of the best and have the patience to hold for the long haul.
Although the great Chinese construction boom that helped to drive the most recent up-cycle in commodity prices has moderated, the Mainland still accounts for 68 percent of global iron ore imports, with much of this tonnage destined for the steel industry.
New infrastructure, machinery, and commercial and residential properties account for about 80 percent of China’s steel demand; growth has slowed in all three of these areas as the county seeks to transition from an economy driven by investments in fixed assets to a services-oriented one.