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5 ways to create value in the mining industry

Published by Bill Hart January 19, 2018

The last decade was a challenging one for the mining industry. For the last few years the industry has suffered from declining commodity prices. In business school, they teach you that the only responsible decision is for the mine operators to sell off non-essential assets and return the balance to investors. Anything else would be irresponsible, the profitability and survival of the corporation is at stake.

While few would dispute that it is the right course; it would be a mistake to see the downturn not as a problem, but as an opportunity.

Today sovereign and private investment banks hold billions in assets that can used to capitalize the resource industry, but before any investments are made one must ask how do mines create value?

From a value standpoint, mines are high capital long-term investments. The reality is that value is a complex engine that can be manipulated with the right expertise. One should really ask how mining companies produce value?

Accountants like to measure value by anticipating share price after expected future cash flows and liabilities have been removed. It is, however, more complicated than that. In mining, most value is created by subsequent Brownfield expansions. But this value is often underestimated in initial estimates. Mining is also cyclical, and humans are notoriously unreliable at extrapolating value. In the end this is probably the wrong explanation. The real answer lies in the uncertainties in the market.

Investors generally consider mining to be a high-risk asset because the minerals will be depleted in the indefinite future. While this is true, no investment is risk free. Risky investments can also sometimes be the most profitable. The key to successful investing is managing the risks. For instance, if investors seek growth through acquisition, then they should have full knowledge of the industry and the associated risks.

In general, there is a set of rules that investors should observe when managing risk.

  1. The highest potential pay off in growth strategy is in asset trade, but investors should be prepared for high-risk monies. This is further complicated by the human psychological bias to buy when the market is rising. Wise investors should resist the impulse and purchase cheap assets.
  2. Greenfield exploration presents high value but also high risk with no guarantee of a pay-off. The exploration of Greenfields can be very complicated and there is not the best track record of success.
  3. Access to infrastructure is indispensable to unlock value. It is also a low risk method of producing value.
  4. Innovation and Brownfield exploration represent low risk methods of increasing value when positions allow.
  5. The efficiency of an operation is unlikely to lead to sustained growth. It is still useful for protecting value.

The Chinese infrastructure market has been declining for years, and this opens new opportunities for asset trading. The trading houses are already purchasing new properties at lower prices, and they will likely soon transition into strategic marketing to create value. Lower priced properties could also be purchased if the market is over-corrected. The technology in the industry has been static for decades, but there are signals that new technologies are maturing that could create value. Trading houses should also be prepared to trade and market properties to maximize value.

One remaining unanswered query is what effect upcoming trends will have on value sources. How do you anticipate this playing out?

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