Why mining is in trouble in SA, and everywhere else

We all know that mining is having a rough time here in South Africa, but as it happens, things are tough all over for companies that dig in the dirt for treasure.

As a result of the Great Recession, commodity prices slumped. This put enormous pressure on mining companies, particularly as it coincided in many places with an uptick in costs for miners. In South Africa, electricity prices and labour costs jumped, while in places like Australia, new taxes and environmental rules put a strain on mining companies' income statements. Adding to the general mess, there was underinvestment in some areas, and some unfortunate asset purchases in others.

Commodity prices have yet to recover, as has the global economy, and many mining companies are being forced to write down assets, even as they must wrestle with challenges ranging from difficult labour relations to changing legislative rules. But in time, they'll recover, and it's possible that investors like Piet Viljoen are right, and mining shares offer great value today. – FD 

GUGULETHU MFUPHI:  Welcome back to Power Lunch. According to PwC, 2013 was a year that forced the global mining industry to realign expectations in one of the most difficult operating environments in four years. Joining us now to take a look at this – the PwC Annual Global Mine Survey – is Dion Shango, Mining Partner at PwC. Dion, thanks for joining us today. What was interesting for me when I read through the report is that quite clearly, the mining struggle are not isolated to South Africa.

DION SHANGO: Absolutely, Gugu. Good afternoon. Mining globally throughout the industry, continues to go through challenges. I remind you that this publication for 2012 spoke of a crisis in confidence and really, this year it's still a bit tentative in the industry and management teams out there have had to realign expectations with regard to all stakeholders.

ALEC HOGG: This write-off of USD57bn…no wonder half the executives lost their heads.

DION SHANGO: Absolutely Alec, and may I remind you? That's on top of USD40bn of impairments in 2012.

ALEC HOGG: How did they get it so wrong?

DION SHANGO: That's a great question. I don't think it's really due to the fact that miners all over the world have suddenly forgotten how to mine or where to derive the best assets. It's really about sentiment in the industry. It's about commodity prices and where they are today. These impairments and write-downs give you a picture of what a company or its management team sees in the future. If the gold price has come down by 28 percent in 2013, what does that say about management's own models, looking forward as to what value they ascribe to the assets? That's really what's driving those impairments. Furthermore, you have to really consider what it is exactly, that management is writing down or writing off. Is it your more intangible assets, such as goodwill, or is it your hard-core tangible property plants and equipment etcetera.

ALEC HOGG: You're giving me a little bit of encouragement here, because Piet Viljoen is big in the resources sector. I had another value investor yesterday, saying the same kind of thing, that that's the only defensive stock on the JSE after a huge run in the last couple of years. Now, if we view the impairments from a longer-term perspective, maybe it's a short-term decline that caused it.

DION SHANGO: It could well be, Alec. As I said earlier, some of these hard-core assets that are written down – your property, plant, and equipment – your financial reporting standards does allow you to write those back in future years, should the assumptions you use for your models change significantly and should you become more bullish/more confident about your industry and your particular company.

GUGULETHU MFUPHI:  Consolidation is also something that you highlighted in this particular report. Are there any particular spheres within mining that might be more likely to consolidate versus others?

DION SHANGO: If you look at all your commodities, then you would believe that. The gold companies are under a lot of pressure and possibly, there, we could see more consolidation. Whether it's friendly consolidation or not so friendly, remains to be seen, but I think everybody's so busy trying to get their own house in order these days that consolidation is probably not at the top of their minds at the moment.

ALEC HOGG: And your stock prices are so low, who would want to issue more shares? You always think you're worth more than the value. What was interesting was your top 40 – the top 40 mining companies…the changes that came in, in the past year.

DION SHANGO: Absolutely. What's interesting to note Alec, is that for the first time, more than half of the top 40 in number comprises companies from emerging markets and in that regard, we would consider South Africa to be more of a developed market from a mining perspective, so that's quite interesting.

ALEC HOGG: So South Africa would be outside of those.

DION SHANGO: Yes, but you have new entrants from other countries. However, the market cap of that top 40 is still dominated by your traditional diversifieds, your BHP's etcetera.

ALEC HOGG: So the gold company's falling out of it.

DION SHANGO: Absolutely. A total of five gold companies falling out of the top 40 in 2013, compared to 2012, with one entrant that did come in, in the form of Rand Gold. It clearly shows you that the sentiment towards gold at the moment and the current confidence in gold companies.

ALEC HOGG: And the siding mining company that made the top 40: what exactly do they do?

DION SHANGO: Absolutely. That's really on the back of a government mandate for that company to go and develop the mineral resources of SARGE really resulted in the first Middle East company to really be included in the top 40 for 2013.

GUGULETHU MFUPHI:  You mentioned government mandate. It also comes to mind when it comes to them wanting to increase their stakes when it comes to mining as well as other exploration with regard to resources. From South Africa's perspective, when you look at our legislation are we trying to keep in line with international regulation or scaring foreign investors off?

DION SHANGO: It's a great question, Gugu. It's a raging debate, isn't it? One gets the sense that government is trying to do the right thing in really being bullish on the industry. Government realises and acknowledges the importance of mining to this economy. However, you still get the sense that there's still room for improvement in the way that government and the private sector interact and the way they talk to each other. They could be a lot to each other. They could be a lot closer to really doing a better job of understanding each other's needs, to understand what difficulties are out there in operating mining companies and to better understand what it is that government needs to derive out of this industry in order to deliver a better life for all its citizens.

ALEC HOGG: Dion, there's been a lot of progress. Talking to Roger Baxter, he says the last 18 years – remember he immigrated to Canada. Then he was brought back to South Africa. He said that for the last 18 months he hasn't had a weekend, because they've been working on this. He's very bullish about it. Of course, the problem that now exists is on the petroleum side – the Oil & Gas side – but I guess that's outside of the scope of your investigations here. Maybe you could elaborate, though. You say that license to operate is becoming more challenging, so it's not just in South Africa where you have more resource nationalism, but pretty much a global trend.

DION SHANGO: Absolutely, Alec. I think that sometimes, if you only look at South African-related news, you would think for a moment that these problems only happen in South Africa, and that is not the case. Stakeholders of mining companies all over the world have similar needs to what we see here at home. Governments want more of the pie. Communities want more of that pie. The real question that should be asked is 'how can all those stakeholders, together with the mining companies, grow that pie to make it bigger' as opposed to everyone wanting a bigger slice of the current pie.

ALEC HOGG: Good stuff.

GUGULETHU MFUPHI:  Well, we got some tips with regard to investors' perspectives, so may you're also bullish on resources.

ALEC HOGG: Of course. I promise you, I don't bet against guys like Piet Viljoen. They're far too clever and rational, so when you get those chaps going big in a particular sector, take note.

GUGULETHU MFUPHI:  They do the math and we just follow – maybe. Thank you so much, Dion Shango, Mining Partner at PwC.

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