How do you spend $344 billion? That’s the question the global mining industry is now facing after years of aggressive cost-cutting, mergers, and efficiency savings.
The figure of $344 billion has been calculated by equity analysts at Morgan Stanly who note that at present, the mining industry is trading at a forward free cash flow yield of 11% based on 2018 estimates.
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The Mining Industry Will Have A Lot Of Cash
The world's largest diversified mining group, BHP Billiton is the perfect example of the cash flow problems (or windfalls) the industry is facing. When commodity prices collapsed in 2015, the company acted quickly to slash costs to the bone and cancel any significant capital projects. As a result, production costs slumped margins blew out, and now the company is awash with cash.
According to the company's results release for the year ending 30 June 2017, over the past five years, the group has achieved productivity gains of $12 billion over the previous five years and is looking to drive another $2 billion in benefits by 2019. Net operating cash flow for the period was $16.8 billion, and free cash flow was $12.6 billion. For the year, the company announced $4.4 billion in dividends to investors and reduced net debt by $10 billion from $26 billion to $16 billion.
After a near-death experience in 2015, the whole mining industry is now targeting cash generation over growth, and according to Morgan's figures, over the next five years the industry will need to decide how to spend a total of $344 billion in cash, or 72% of current capital employed:
"We estimate 2018 FCF on a spot price scenario of USD52 billion for our coverage (11% yield). That is after spending USD36 billion on capex (versus a peak of USD81 billion in 2012) or 1.0x depreciation. Dividends will absorb USD27 billion, on our estimates using the new payout policies. With net debt to EBITDA down to 0.9x in December 2017 on spot, the balance sheets are largely fixed. That implies the industry needs to allocate USD25 billion in excess cash per year or USD61 billion in total, including regular capex."
With so much extra capital, it's possible miners could slip back into old habits, spending billions on un-economic vanity projects. However, Morgan's analysts believe that the sector has made concrete steps to prevent this from happening by re-organizing dividend policies:
"The recent switch towards earnings and cash-flow based dividend payout ratios is an important step. In periods of excess profits, cash distribution to shareholders will automatically lift in proportion. In the past 15 years, a significant share of that cash was allocated to poorly timed investments or share buybacks. Over the super cycle (2004-2012) BHP and Rio Tinto allocated 83% of the available cash to capex, M&A and buybacks, and only 17% was returned via dividends. On average, diversified mining companies are now targeting minimum payout ratios of around 50%"