Managing Director & Senior Partner
Since its peak in 2010, the mining industry’s performance has, in characteristic cyclical fashion, taken a sharp downward turn. Companies have continued to destroy value at a time when the S&P 500 has hit record highs.
The Boston Consulting Group analyzed the performance of 101 mining companies in the period from 2010 through 2014. We found that these companies delivered a median TSR of –18 percent each year during that time. (See Exhibit 1.) Looking only at 2014, we saw a slight improvement: a median TSR of about –4 percent. That is, roughly half the companies showed signs of recovery, while others declined further.
Coal companies were particularly hard hit; a rising abundance of natural gas and oil supplies depressed energy prices, including the price of coal. Slowing economic growth in China dampened demand for both metallurgical and thermal coal. In addition, heavy debt loads put downward pressure on valuation multiples. The impact on American coal companies proved especially harsh, and several now face financial difficulties. The gold sector started the year relatively strongly, but except for a handful of outperformers (such as Newcrest Mining and Randgold Resources), its momentum reversed by year-end. The price of gold dropped by almost 40 percent to around US$1,200 per ounce by the end of 2014 and has continued to decrease in 2015. Fertilizer companies, on the other hand, have performed relatively better, bolstered by improving prices for key crop nutrients.
Such disappointing results stand in stark contrast to those in 2000 through 2009. During that period, the China-driven price boom fueled growth in profits, unleashing a wave of new, often capital-intensive, projects designed to take advantage of surging demand. This robust growth boosted investor expectations, causing valuation multiples to expand. Together, these factors drove stock prices sharply upward, even after the effects of the financial crisis of 2007–2008 are taken into account. Indeed, the growth in production is still apparent today. More than 60 percent of the companies in our sample saw revenues increase during the period 2010 through 2014, despite falling commodity prices.
So what triggered the reversal of fortune? From 2010 through 2014, the increase in unit costs, coupled with the decline in margins, erased a median 7 percentage points of TSR from our sample. These trends more than offset the economic benefit of increased production. As a result, only one-third of the companies we analyzed experienced growth in profits over these years. In addition, investors’ waning appetite for mining stocks during this time nudged valuation multiples lower. All told, only 11 companies recorded a positive TSR for the period. (See Exhibit 2.)
As boards and executive teams have grown more cautious about the outlook for prices and demand, they have scaled back, delayed, or canceled growth investments. Total capital expenditure by companies in our sample declined more than 20 percent from its 2012 peak. Industry debt levels remain historically high: with the decline in stock prices, they were at approximately 25 percent of enterprise value at the end of 2014. In the U.S. coal sector in 2015, this ratio exceeds 75 percent at many companies, which makes them particularly vulnerable to external shocks.
Divestments and spin-off activity also increased over the period 2010 through 2014, as companies sold noncore assets that no longer aligned with their broader strategy. Such moves have not been without challenges, however; assets have been hard to off-load, and many remain “on the block” because buyers are not willing to match sellers’ price expectations.
Since 2010, as the prospects for value creation have worsened, mining company executives have increasingly implemented productivity programs. Approaches to productivity improvement have varied. Many companies tackled the simplest, most readily achievable improvements first—such as cutting overhead costs or focusing on high-grade zones within existing operations. Others took further steps, such as ensuring that their organizations are focused on the highest-value activities or deploying technology to rapidly identify and realize value opportunities.
In most regions—and for many commodities—unit costs have stabilized or started to decline after a decade of increases, although they are still well above the levels of 2009. While this is good news, the decline in commodity prices since 2011 has erased much of the benefit that generally stable or reduced unit costs have provided. Industry margins have also continued to fall, from a high of 42 percent in 2010 and 2011 to 33 percent in 2013. This trend continued into 2014, as prices for coal, gold, and iron ore declined further.
Basic productivity efforts are running out of steam in two respects: in their ability to achieve further cost decreases and in the sustainability of their first-wave results. If economic trends are any indication, commodity prices cannot be relied on to revive ailing TSR—at least not in the near term.
To achieve breakthrough productivity—the kind that leads to sustainable improvements in margin—executives and operators need to think differently about how their assets are organized and managed, where costs and value accrue, and which activities deliver the most (and least) value to the organization.
Over the past several years, BCG has developed a holistic approach to productivity improvement, based on our experience with more than 150 projects worldwide. This approach is maturity-based, optimized, sustainable, and transformational—hence the name MOST. MOST is both a diagnostic and an improvement framework. It helps companies optimize not only their internal operations—within and across functions, processes, and systems—but also their external interactions with suppliers and customers.
Because it is based on a strategic view of the asset—that is, mine, milling, and processing facilities (and sometimes transportation equipment)—MOST enables companies to transform their operations to align with their role in the total portfolio.
MOST facilitates designing a productivity program that deals with the operation’s performance in three dimensions: the efficiency of physical assets, the effectiveness of management systems, and the level of people excellence. Taking a triage approach, MOST targets the least mature areas—that is, the weakest links—first.
The interrelationships among the three dimensions, of course, are significant. For example, achieving efficiency with physical assets amounts to more than eliminating production bottlenecks. It calls for having a better understanding of each resource’s potential; for reevaluating the mining method, configuration, and equipment selection; and for seeking a technology advantage through targeted investments that boost throughput and reduce costs.
To illustrate how the MOST framework can help uncover and unleash new sources of productivity, consider its application in contractor management. Contractor management is an area of expenditure that traditional productivity and lean programs often struggle with—but that holds great potential. Indeed, successful contractor management goes far beyond squeezing rates and payment terms, moves that can ultimately be counterproductive.
There are three broad aspects to contractor management, all of which offer opportunities for productivity improvement:
We have identified eight value levers that companies can apply to enhance the value delivered by contracting. (See Exhibit 3.)
For instance, contract demand management calls for reviewing service standards, required procedures, or technical standards (or all three), as well as simplifying contract requirements and reporting structures. For example, one company realized significant savings in a blasting contract by reducing the number of blasting trucks on hand, a number previously sized to accommodate peak demand for blasting services.
The contract consolidation lever involves consolidating small contracts, setting a common base for contract fees, and reducing general and administrative expenses. One company that consolidated its four different auxiliary-equipment leases realized a savings of 15 to 25 percent of its annual expenditure.
Contract scope breakup seeks opportunities for efficiencies by segmenting contracts that require different services or capabilities on the basis of the scope of their component parts. Among other things, it enables more competitive bidding than an integrated contract. As an example, a haul truck maintenance contract was rescoped to allow local contractors to perform some lower-skilled activities at a rate below that charged by a full-service, integrated services provider. This saved the company about 15 percent of the annual contract cost.
Contract delivery control involves implementing systematic controls to monitor prices and fee adjustments, guarantee service delivery, and ensure that contractual penalties are applied when appropriate. In one case, a company earned US$1.2 million from inventory-level penalties that were contractually negotiated but that had been overlooked during the execution of the contract.
To maximize the value of contractor management, of course, companies will want to apply as many value levers as are appropriate to any given contract. On average, applying multiple levers can generate a total savings of 10 to 20 percent of the contracted cost.
Successful companies recognize the role that a long-term and integrated productivity program plays in value creation. Yet such programs alone are not enough. Other levers are needed. Chief among them is profitable growth, both organic and through acquisitions.
Reassessing the Project Pipeline. Given the extremely long lead times inherent in getting growth projects into production, companies with the means to do so should begin upgrading their project pipelines. Mining executives will want to reexamine projects not yet under way, perhaps even radically rethinking available options by stepping back to the prefeasibility level of study. This is especially important for projects that were proposed before the global financial crisis and the ensuing economic and market volatility.
Executives might also want to revisit projects already under way—major capital projects as well as capital expenditures needed to maintain existing operations—reassessing them in light of the revised outlook for commodity prices, costs, and capital. This review should include reevaluating the options afforded by new technologies that have become available since the projects commenced.
Pursuing M&A Opportunities. Mining company valuation multiples, transaction multiples, and acquisition premiums are all low relative to prior years. Companies with the financial means have engaged in selective acquisitions to take advantage of the current low valuations—consider First Quantum Minerals’s acquisition of Inmet Mining and the joint acquisition of Osisko Mining’s Malarctic mine by Agnico Eagle Mines and Yamana Gold.
Some acquirers have been very successful. Northern Star Resources, based in Australia, grew from being a gold explorer to a prolific (350,000 ounce per year) producer following a series of well-timed, well-executed buys—largely of assets divested by larger companies. This strategy has rewarded Northern Star’s shareholders well, delivering an annual TSR of more than 100 percent since 2010.
Opportunities to strike value-creating deals over the next few years will be especially important for those companies and teams with a differentiated ability to add value to acquisitions.
Recognizing Technology’s Value-Creating Power. Technologies such as robotics, the industrial internet, real-time data monitoring, and analytics have radically transformed manufacturing and production processes in a range of other industries. Industries with controllable environments—those under one roof, such as automotive manufacturing—have integrated their processes end-to-end using automation.
Mining, however, is a geographically dispersed business with inherent variability in geology and weather. The use of advanced technologies has thus often been seen as a difficulty. Today, however, some companies are discovering opportunities to use automation and the industrial internet to drive greater integration throughout the mining value chain. Apart from their many other benefits (such as greater employee safety and lower environmental impact), next-generation mining techniques are fundamentally a means of improving productivity. Autonomous drilling, trucks, and trains allow companies to achieve massive gains in surface mining, as well as greater yields in mining more complex deposits.
Access to real-time operational data is also advantageous: when integrated with maintenance data, real-time operational data enables companies to monitor plant productivity, plant utilization, availability, hourly output, and reliability more accurately—and make smarter, more informed decisions in the field.
In the past few years, creating value has been a struggle for the mining industry, amid slowing demand, rising costs, falling prices, and waning investor interest. In response, many mining companies have implemented productivity programs. However, as the supply of “low-hanging fruit” is exhausted, it has become increasingly necessary to go beyond traditional approaches to productivity improvement, which often focus on the efficiency of physical assets. Companies also need to consider the effectiveness of management systems and the level of people excellence. Indeed, opportunities to enhance productivity can be sought both within and across these three key performance dimensions. When applied holistically, measures to increase productivity can have considerable impact in reducing unnecessary costs, boosting efficiency, and enhancing value.
Once in a position to do so, executives need to consider other value-creation levers, including resuming the pursuit of profitable growth. Management teams must prepare themselves now to be in the most favorable position to capitalize on opportunities as they arise. To generate value in organic growth, they need to refine the quality and certainty of their project-development pipeline. To reap greater value from acquisitions, they will need to streamline the processes by which deals are selected and benefits realized. Beyond these actions, strategic investments in technology can unlock even greater value for both present and future operations. While the past few years have been challenging, there is still great potential to create value in mining—and moving beyond basic productivity is one avenue for doing so.