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Industry Analysis: Metals & Mining (Diversified)
Diversified Metals & Mining companies supply commodities used in products and equipment found in a wide variety of sectors, such as construction, automotive, aerospace, and telecommunications. In fact, this industry’s reach is so broad that the utilization rate of metals is a key barometer for gauging the health of the global economy. The presentation of historical figures, estimates, and projections for companies in this group follows the standard Value Line industrial page format.
An important factor that determines a miner’s performance is its ability to maintain a favorable level of production. The best performers typically have a good number of high-quality mining asset locations, with substantial commodity reserves and low operating costs. The earth’s resources are, of course, depletable, and extraction is becoming more difficult. Over the decades, sweeping advances in extraction technology have nicely improved the success rate of new mines. Most companies devote a significant portion of their capital expenditures to develop more effective techniques to extend the life of existing mine sites. Acquisitions are an alternative to building reserves and production. Investors should consider that even some of the most established mining firms will experience disruptions in output from time to time. Inclement weather, mechanical failures, political unrest, and strikes by workers are common causes of production delays. Metals producers may engage in contract hedging activities, or locking in a commodity’s price at some future date to guard against price declines, with the aim of making earnings more predictable. Hedging can, however, lead to lost profit opportunity if a commodity’s price rises more than expected. Some miners limit their use of this strategy, and, consequently, their results, tied to swings in metals prices, are quite volatile. Additionally, companies that conduct substantial international business may turn to foreign currency hedging to smooth reported results over the entire economic cycle.
Until recently, the United States and other major industrialized countries, including those in Western Europe and the Pacific Rim, have historically been the primary consumers of metal. But, in the past several years, developing nations, most notably Brazil, Russia, India and China, have risen in prominence. Their expanding infrastructures and middle-class populations suggest greater commodities demand in the coming years. Economic activity in all countries will surely continue to ebb and flow like the tides, compelling producers to quickly adjust to fluctuations in short-term demand, but the long-term trend is positive. It does take time to shut down or reopen an operating facility, so miners that misread cyclical trends can get into trouble fast, posing a risk to profits (and shareholder value).
Taking commodities prices into consideration, a mining company must weigh the viability of certain operations in accordance with their input costs. Exploration and capital equipment entail the greatest outlays. Electricity, diesel fuel, coal and natural gas also account for a substantial portion of total expenses. When metals prices fall to a nadir in a given cycle, facilities, starting with those that have the highest costs, will be shuttered. Conversely, when commodities prices are very favorable, all available assets, regardless of operating costs, will likely be utilized to maximize income.
Mergers and acquisitions are not uncommon in this industry. Companies usually pursue combinations to boost mine reserves and achieve production economies of scale. M&A also may offer access to attractive new markets and help to spread operating risk across a wider geography. Despite the industry’s long history, there are still a fair number of small operators in existence. Many will crop up when business conditions are very positive. The level of M&A activity is dependent on a myriad of factors, such as the broader economic climate, regulatory oversight, and stockholder influence. In all likelihood, deal making will continue to play a role in the industry for many years to come.
The companies that have the best operating track record in this sector tend to have substantial mine reserves, an extensive pipeline of viable projects, relatively steady production, and a strong financial profile (i.e., healthy cash flow, a solid cash balance, and manageable debt burdens). Other attributes of successful industry players include the ability to create and utilize innovative extraction technology, a large presence in politically stable regions of the world, and effective asset and operating cost management. Diversified Metals & Mining stock valuations are closely tied to commodities prices, which are determined largely by supply and demand fundamentals. Not only does the health of the broader world economy have an impact on the fortunes of the industry, but specific sectors, such as housing, auto, aerospace, and information technology, can weigh in on results in any given period. Consequently, the stocks in the industry carry high beta coefficients and below average scores for Price Stability. Too, the companies’ Earnings Predictability ratings tend to be low. Thus, we advise only accounts with a high tolerance for risk consider a commitment here. Investors need to closely monitor the mining business cycle to enter at the most fortuitous point for potential capital gains.