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Q: Do you change your business or the way your business works?
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Volatility has been an ongoing challenge for companies seeking to maintain a strong balance sheet and develop plans for long-term profitability. This is a challenge that management will need to deal with for some time.
Fluctuations in commodity prices have become more rapid and frequent as commodity demand has become increasingly unpredictable. The longer-term economic outlook is also volatile, leading to the possibility of substantial revisions to long-term metal price forecasts and making it hard for mining and metals companies to plan for the future.
The impact of China and emerging market demand is also difficult to understand or predict. So as prices fluctuate and there is limited pricing or demand visibility, management is struggling to plan operations and capex.
Investment decisions and business strategy need to factor in the variability in outlook, particularly as long-range business forecasts (e.g., metal/energy prices, FX rates) are updated. The following graph illustrates how copper prices and quarterly long-term consensus price forecasts have changed since 1 January 2000.
The key to success is agility and getting into shape to deal with volatility now. It is important to focus on six areas that will lead to more effective cash management.
- Cost Reduction
Creating sustainable and long-term value
During the mining boom, miners saw costs escalate in some cases by over 200% (such as fuel, energy and people). Initially higher commodity prices masked these costs, but as prices have fallen, these embedded higher costs have been impacting bottom lines. Miners started eliminating costs from all areas of the business, including reducing capital expenditure and labor. However, there are still a lot of opportunities to remove costs from the business, and miners need to maintain a focus on building a long-term sustainable cost base while making certain that cost reduction activities do not contribute to value erosion. This can be achieved in the areas of general expenses, low-cost country sourcing, offshoring/outsourcing and procurement.
- Working Capital
Unlocking cash in the sector
Mining companies focused on working capital have typically achieved reductions of 30% or more. For larger mining companies, this can mean reclaiming hundreds of millions of dollars of capital back into the business.
Processes and systems across the supply chain, particularly with regard to inventory, accounts payable, and WIP and finished goods, are the biggest areas where gains can be made. The next wave of improvements will require cultural change and data analysis.
- Productivity
Productivity remains the number one operational challenge in the mining sector, with many still struggling to make an impact. Gains to date have been realized via tactical short-term solutions, but to really achieve sustainable gains, the focus needs to be on the long term. In our experience, most of the obvious opportunities across operations have already been addressed — it’s finding the next 10%–20% of productivity savings that can be difficult and complex.
A relentless focus on the elimination of loss at all levels is needed for the next wave of sustainable productivity improvement. We define loss as any gap between the achieved output and the potential productivity of an asset or a system of assets. It includes elements of reliability/availability, utilization rate and quality.
Whether the objective is a rapid uplift in productivity, or a long-term sustainable change, the principles remain the same. Companies need to embed sustainable loss elimination practices through employee engagement and an integrated end-to-end approach for long-term sustainable improvement in productivity.
- Capital effectiveness
Making your existing assets work harder
A program built on the back of good asset management fundamentals will work as a platform to drive productivity and manage risk. Extracting more value from existing assets presents an opportunity to improve asset management capability. This can help to drive productivity and manage risk in a cost-constrained environment.
Key areas to achieve this is through advanced asset management, sustaining capital and capital productivity.
- Portfolio Strategy
Capital allocation and portfolio strategy are critically linked
Empirical research suggests that companies that actively and dynamically manage their portfolio of assets achieve better longer-term returns than companies with a buy-and-hold strategy. For the mining sector, with capital decisions played over such a long period of time, and profitability so intrinsically linked to broader macroeconomic factors, effectively managing portfolios is a difficult task. This is made even harder with the heightened level of volatility being experienced.
Active portfolio management will remain a key priority in constructing an optimum portfolio. There needs to be a focus on optimizing the performance of assets through portfolio improvement and cost control measures.
- Financing
Balance sheet flexibility is key during this period of volatility
While there is a significant level of debt across the sector, and leverage is high on the back of lower earnings, a large proportion of debt is covenant lite and many corporates have taken action to push out maturities and reduce servicing costs. The associated distress, therefore, is perhaps lower than might otherwise be expected in such difficult market conditions.
Balance sheet flexibility remains critical during this period of volatility, and so does the associated “right-sizing” of debt levels to the underlying profitability of operations. Releasing capital to pay down debt can be achieved via dividend cuts, divestments and streaming.
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