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The Struggle of South Africa’s Mining Industry

By Hein Boegman

SA’s mining industry faces leaner times in the wake of recent industrial action and mounting costs.

According to a report issued by professional services firm PwC, a tough year for the mining industry lies ahead in the wake of recent industrial action, mounting cost pressure and shrinking profit margins. While the 2009-2011 period was characterised by a recovery in overall commodity prices from the lows of the 2008 financial crisis, in 2012 this recovery slowed, with gold the only commodity gaining value.

A weakening rand over the period managed to shield the South African mining industry from the decline, with prices remaining relatively flat. However, flat prices will not support the industry’s significantly increased cost base.

This article discusses highlights from PwC’s fourth edition of ‘SA Mine’, which published findings on trends in the South African mining industry. These findings are based on the results for the financial year ending in June 2012 of the top mining companies with primary listings on the JSE, as well as those with secondary listings whose main operations are in Africa. The selection criteria for this study included companies with a market capitalisation of more than R200 million and excluded global mining companies Anglo American and BHP Billiton, as these organisations do not necessarily reflect trends in the South African mining environment.

In general, of the 39 mining companies surveyed, industry balance sheets remained strong and with stable liquidity in 2012. It is however anticipated that significant margin pressure will result in a challenging 2013.

Market capitalisation
The 2012 financial year saw the top 39 mining companies shed all the gains made since the 2008 financial crisis. Market capitalisation for the top 39 declined by 9% from R910 billion in 2011 to R833 billion in 2012, reflecting a 3% decrease in market capitalisation of R862 billion in 2010. On the back of strike action, the position weakened even further and reflected a market capitalisation of only R792 billion at the end of September 2012.

The tragic events at Marikana and widespread labour disputes have significantly impacted the mining industry, with mining companies rethinking their risks and the risk landscape in which they operate. It is now imperative that they evolve their risk assessment practices to be more predictive in anticipating and planning for future potential risk events. Although these events were not the only factors that affected market capitalisation, they played a key role in the decline of the top 39’s market capitalisation by 5% from June 2012 to September 2012. Of the top 10 companies, six posted declines, with Anglo Platinum, Kumba Iron Ore and Exxaro Resources collectively losing R40 billion in market value.

Contribution by commodity
Coal overtook platinum as the highest earning commodity in South Africa. The report says that it is unlikely that platinum will regain the top spot in the short term due to the slower than expected recovery in global markets, the recent economic uncertainty and lower production as a result of industrial action. For the three main revenue generating commodities, gold is the only commodity to have gained in real terms, with the price of coal remaining flat.

Financial performance
Revenue increased by 16% in 2012 (compared to 36% for 2011) on the back of higher commodity prices and a weaker rand towards the end of the period. Gold companies reflected the best growth with a 25% increase, while platinum companies recorded a mere 2% growth. The remainder of the companies recorded average revenue increases of 22%. Operating expenses increased by 13% as opposed to the 18% recorded in the prior year.

Although the share of labour costs as a percentage of total operating expenses decreased from 39% to 36%, when one compares this year with the previous year, it remains by far the biggest component of the mining sector. Over the past five years, wage increases in the mining industry have not only superseded the CPI, but have averaged one to two percentage points higher than the national average of wage increases across all industries.

The changing risk landscape
The requirements of the King III Report on Corporate Governance have resulted in improved disclosure of risks by all organisations, with mining companies in particular excelling at disclosing these risks. However, Boegman says the challenge remains to link adequately performance and risk management and to put the necessary measures into practice. The regulatory, political and legal environment, followed closely by employee skills and safety, were among the most common risks disclosed by the companies included in their risk analyses.

Much has been made of the perceived inability of mining companies to meet the initial compliance targets set out in the Broad-Based Socio-Economic Empowerment Charter (the Mining Charter) for the mining industry, with compliance targets for 2014 set significantly higher than previously. Apart from the 26% ownership target, the required procurement spend with BEE entities of 40% for capital goods, 70% for services and 50% for consumables is bound to be a challenge.

The build up to Marikana and the ensuing industrial action across the industry has highlighted the need for mining companies to maintain direct communication channels with workers. The higher labour cost base, coupled with the contraction of mining activities, has already led to significant retrenchments and more are likely to follow. The report notes that the process of retrenchment and its effect on communities could aggravate the current spiral of negativity and sustained violence in mining areas and may lead to political interference.

Mining developments have also led to an influx of people into mining communities, attracted by the hope of securing direct employment, or indirect employment in providing goods and services to mine employees. The limited resources of individual mining companies fall well short of community expectations, considering the scale of migrant influx, the lack of service delivery by local governments, the use of housing benefits for other purposes and the apparent inability of stakeholders to agree on social upliftment projects.

Furthermore, the availability of funds for capital expenditure is currently limited, with investors adopting a wait-and-see approach to the South African mining industry. Postponed or stalled capital expenditure may hinder the ability of mining companies to ramp up production in time to benefit fully from future commodity price increases.

On the other hand, over-optimistic long-term investment assumptions may result in inadequate cash flows to redeem debt, maintain equipment and reinvest in the business.

Safety in mines
Safety statistics indicate a higher level of focus on safety, and there appears to be only marginal improvement in this area. Of the top 10 companies that disclosed lost-time injury frequency rates, Kumba Iron Ore reflected the best record with regard to lost-time injuries. AngloGold Ashanti showed the best improvement over the previous year, while a total of seven companies improved their statistics compared to the prior year.

Improving value to stakeholders
The mining industry adds significant value to South Africa and its people. Stakeholders in the industry include employees and their families, unions representing them, the Government as regulators and custodians of tax income for the country, investors, suppliers and customers. The monetary benefit received by each stakeholder in the industry is usually summarised in mining companies’ value added statements. The state received 16% in 2012 (as opposed to 18% in 2011) consisting of direct tax, mining royalties and tax on employee income deducted from employee salaries. The report states that although the percentage of the value created by the state has declined by 2% from the prior year, the actual value of collections by the state for the represented entities remained stable in comparison with the 2011 year.

The percentage of value that is collected by providers of debt capital reduced marginally from 3% to 2%. This low percentage reflects the conservative levels of gearing in the mining sector. The 18% (2011:12%) received by the providers of equity capital increased from the prior year and reflected the volatility of returns to shareholders.

Boardroom Dynamics
Of the annual reports reviewed in this study, 33 companies disclosed the composition of their board members. An analysis of these companies found that the mining industry currently exceeds the minimum empowerment levels of board representation required by the Mining Charter.

Presently, 46% of board members comprise historically disadvantaged individuals. The Mining Charter requires a minimum of 40% representation by 2014.

Tax transparency
Globally, there is a drive to improve tax transparency with regard to tax payments made to governments and how those funds are utilised for the development and upliftment of those countries and their people. A range of transparency initiatives are currently in effect or being proposed, with the spotlight predominantly on the mining, oil and gas industries. These sectors often operate in developing countries and by demonstrating what they pay to governments in taxes and royalties in return for extracting natural resources – and what they contribute to the local economy – may be vital for maintaining important stakeholder relationships and a licence to operate.

Certain large mining companies have significantly amended how they report on tax, demonstrating that the business case for tax for transparency outweighs the possible risks. Companies are becoming more sophisticated in their approach, allocating greater resources to the governance and management of tax. They are also setting ‘best practices’ in their industries and are becoming more transparent about their corporate tax affairs, tax strategy, tax risk management, tax numbers and performance, as well as their total tax contribution and the wider effect of tax on the organisation.

Looking ahead, these trends are set to continue and intensify, as a diverse group of external stakeholders has become more interested in tax in the corporate sector and is asking companies to provide more extensive and varied information about their tax affairs.

In South Africa, a concerted effort is now being made to deal with acid mine drainage and its cost to the environment and affected communities.

Gone are the days when risks for companies were limited to health and safety issues. Mining companies now need to integrate risk and performance management.

The changed environment requires vision and leadership from boards of directors and executive management. These leaders will have to steer their companies through the near term low margin challenges, while recognising the impact on all stakeholders involved.

Hein Boegman CA(SA) is PwC African Mining Leader.

This article was originally published in the February 2013 issue of ASA.