It's time to ease the capital austerity

SHAREHOLDERS have been clamouring for their fair share of returns in recent years. But if companies want to take advantage of a low point in the commodity cycle they’ve got to wean themselves off those short-term investors.
It's time to ease the capital austerity It's time to ease the capital austerity It's time to ease the capital austerity It's time to ease the capital austerity It's time to ease the capital austerity


Andrew Duffy

That’s the view Ernst and Young mining leader Mike Elliott has arrived at after completing a long-term study of the mining sector.

Elliott, along with his colleagues at EY, has shown that well-timed acquisitions can drive some of the best returns in the long term.

There’s one big problem though. While that approach makes sense on paper, big companies in particular are finding it hard to find support to go deal hunting.

“Companies have felt a large amount of pressure to return capital because essentially the market lost trust in the way they were allocating it,” Elliott said.

“In many ways the low returns that were observed 18 months to two years ago really inspired that movement from shareholders.”

Short term focus

The commodity super cycle attracted non-traditional investors to the resource space, and that influence has pushed a number of companies into making larger capital returns in recent years.

There are signs that trend might be starting to change, however, with Elliott’s research showing a number of big firms cutting dividends.

Vale, Teck Resources, Freeport-McMoRan, First Quantum Minerals, Cliffs Natural Resources and Peabody Energy all cut dividends in 2015, and there are other signs suggesting companies might be placing a greater emphasis on growth.

“Sometimes right at the point of the tide turning you can’t really tell if it’s coming in or going out,” Elliott said.

“I think we may well be in that particular state now.

“We’re shifting from the period of capital austerity that has been imposed in the last couple of years to seeing some of the more traditional long term investors saying if you don’t start looking at growth then you may miss the opportunities that are emerging.”

In the wider sector the focus on short term returns has opened a window for private capital.

Private equity is not subject to pressure from short term investors, and that freedom gives it more leeway to make counter cyclical investments.

“There are a lot of very sound reasons as to why you would be counter cyclical if you could,” Elliott said.

“If you can be counter cyclical then you can buy cheap and sell high. You can construct at a low cost when there’s plenty of resources and you can time your entry just as prices are rallying.”

Mixed messages

In recent weeks we’ve seen a major shareholder in BHP push for a more growth-oriented strategy, and that approach makes perfect sense.

Right now debt is relatively cheap and small and large companies alike still have a strong pipeline of growth projects.

Taking stock of the current climate, the gold sector has seen its fair share of deal making and many executives have tipped that trend to continue.

The number of mineral sands deals has also jumped as miners and developers make a punt on prices finally bottoming out.

There are still signs of big capital returns playing out, however, with Rio undertaking a share buyback in order to curry favour with some investors.

Elliott said that approach might work in the short term but it was “anathema” to the long-term model.

He said it was yet more evidence of a clash between short and long term investors.

“The length of the super cycle meant we were in an upswing for so long that the correction seemed really strange to a lot of investors and to some extent the companies themselves,” he said.

“This is a cyclical business though. It will have its ups and downs. You’ve got to be able to prepare your business to operate in all of those circumstances.”

While all companies have a diverse register the challenge of balancing out competing investors is a particular test for big companies.

Moving forward Elliott said those companies needed to find a way to transition away from the short-term stakeholders.

“Companies need to – not radically – but progressively wean themselves off that cash and switch that back to the more traditional long-term money,” he said.