Valuation Of Metals And Mining Companies via CSInvesting
Svetlana Baurens
In collaboration with the University of Zürich, Swiss Banking Institute and Prof. Dr. T. Hens
Date: 7.11.2010
Valuation Of Metals And Mining Companies - Introduction
1.1 Motivation
Mining and metals continue to be among the best performing global equity sectors, but conflicting issues – from “pricing bubbles”, “imminent recessions”, “demand destruction” to “resource scarcity”- are confusing investors. Nevertheless, the importance of mining to the world has become very apparent in recent years, as commodity and equity prices have exceeded most expectations.1 Therefore, investments in commodities become more attractive as a long-term investment as they are a safe haven in times of economic crisis and provide a protection against currency devaluation. Thus, it is useful to know how to value metals and mining companies.
The prediction of the value of a mining company is a complex matter. Various methods are available to estimate a company’s value but many are not useful or applicable. The reason is the specific nature of mining industry. Aside from the usual financing risk in the case of mining producers, and financing and “finding” risk in the case of pure exploration companies, there are price cyclicality, ongoing changes in operating and capital cost structures, stock market vagaries, and volatility in circumstances.
Consequently, even traditional methods such as Discounted Cash Flow, Relative Multiples or Real Options cannot be applied without some adjustments and demarcations. For example, cash flow or earnings based valuation methodologies may not be relevant for the valuation of a mining exploration company that has no production assets or revenues, neither operating cash flow or earnings.
The purpose of this paper is to find out which valuation methods are available for valuing metals and mining companies and explain why these companies are valued this way in practice.
The paper takes the reader through different stages of metals and mining companies from mineral exploration to mine production and provides an overview of suitable valuation approaches, discussing some of the difficulties and limitations that arise in using these approaches.
1.2 Structure
This study is organized into eight chapters:
Chapter 1 introduces the study and provides definitions of specific terms used in the metals and mining industry.
In Chapter 2 special features of metals and mining companies are discussed to provide the broad basis that is essential to understanding the nature of the mining sector. A subchapter of Chapter 2 summarizes various valuation approaches usually applied for valuation of mining and metals companies and defines methods which are in the focus of this paper. A second subchapter characterizes resources and reserves to give readers’ clear understanding of important differences between a mineral resource and a mineral reserve.
Chapter 3 describes exploration properties and suitable valuation methods for them, such as Appraised Value and Comparable Transactions.
Chapter 4 explains why economic and price cycles are very important when valuing mining companies. It also gives an idea how to avoid commonly made mistakes when valuing metals and mining companies.
Chapter 5, 6 and 7 describes Discounted Cash Flow, Multiples and Real Options methods and discusses applications for metals and mining companies.
Chapter 8 is a practical chapter. A copper mining group, Antofagasta, is valued with different valuation methods.
1.3 Definition of terms
Valuation approaches for metals and for mining companies are similar; therefore, for convenience the term “mining companies” will be used for “metals and mining companies”.
It is necessary to know what some subject-specific terms mean. Thus, there are some important terms definitions:
Metallurgy is the study of metals: the study of the structure and properties of metals, their extraction from the ground, and the procedures for refining, alloying, and making things from them.
Mining is the science, technique, and business of mineral discovery and exploitation. Mining includes all activities related to extraction of metals, minerals and gemstones. Strictly, the word connotes underground work directed to severance and treatment of ore or associated rock. Practically, it includes opencast work, open cut work, quarrying, alluvial dredging, and combined operations, including surface and underground attack and ore treatment.
Exploration is searching for natural resources: the testing of a number of places for natural resources, e.g. drilling or boring for samples that will be examined for possible mineral deposits. Exploration aims at locating the presence of economic deposits and establishing their nature, shape, and grade.
Desktop-study is an archaeological research to outline the Site History, Geology and Hydrogeology, and any environmental risk associated with that particular plot. Desktop Study is often required by local planning authorities, when applying for planning permission.
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