Miners Reduce Spending on Projects
Tony is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The major global players in the mining industry are doing an about face and reducing their capital expenditure plans. The miners are doing so because they are being squeezed by two forces, escalating cost pressures and a murky growth outlook, particularly for the biggest consumer of commodities like copper, iron ore and coal – China. Another factor is that mining firms are facing building pressure from their shareholders to return funds to them in the form of either expanded share buyback programs or increased cash dividends.
Just two weeks ago, both BHP Billiton ADR (NYSE: BHP) and Rio Tinto ADR (NYSE: RIO) signaled they would rein in their spending plans in response to these growing concerns. Rio said it would delay some development projects while BHP stated it would stagger its expenditures to match its cash flows, potentially slowing the development of three mega projects the company has in the works.
This is a key point for investors to take in since these two companies alone account for about a third of total capital investment in the industry this year.
Many analysts around the globe which follow the top 40 mining companies have sharply reduced their expectations for spending this year. Expenditures in the sector are now forecast to rise by only 13 percent in 2012 versus earlier predictions (from only a few weeks ago) of a 34 percent rise for the year. In addition, most that follow the industry now expect an actual decline in expenditures next year.
So how should investors look at the new reality in the mining industry?
Mining companies like BHP and Rio have had several great years, boosted by rising prices for the commodities they sell. But now with a weakening China, managements at these firms will likely turn their focus to the conservation of cash. This will be bullish in the very long term for the commodities they produce since many major projects which were expected to come onstream in the next few years may now not come to fruition for many years. In the meanwhile, these companies are rich enough that they can afford increased payments to shareholders to keep them happy in this upcoming dull period for earnings.
Of course, the cutback in capital expenditures by the mining companies will not only effect the miners themselves, but also the mining equipment companies including Caterpillar (NYSE: CAT) and Joy Global (NYSE: JOY). These companies have benefited greatly as demand for trucks, excavators and other mining equipment soared to feed China's appetite for raw materials.
Analysts such as Natalia Mamaeva at Citigroup summed it up this way, “This [capex cutbacks] is certainly a negative development for sentiment around the mining equipment suppliers.” However, stockholders in these type of companies should not despair. Take Caterpillar, for example. It has already booked orders to deliver mining trucks into 2014 and has similar long lead times on other pieces of large equipment. So for at least the next couple years, the effects due to the capex cutbacks will be cushioned.
As far as Joy goes, it has also been affected adversely by the current weakness in the US coal industry. That has dragged the stock down considerably from its high. The stock is down so much that some firms like RBC Capital believe that all the bad news has already been factored into the price. They may be right, but don't look for a quick rebound in these stocks.
The better bet may be the mining companies. The cutback on capital expenditures will slow the inflation occurring in their costs (labor, equipment, etc.) to mine metals. A company like BHP Billiton may be particularly resilient not only because of the strength of its balance sheet, but with its recent heavy diversification into energy, it may feel any weakness in metals less than its peers.
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