Mining in South Africa: What to Expect in 2016

The global commodities downturn is reshaping South Africa’s mining sector, with share prices down and consolidation activity on the rise. The trends ushered in by the events of 2015 mean lean times for some, and deal-making opportunities for a bold and well-positioned few.

“It’s déjà vu all over again”, as late US baseball player, Yogi Berra once said. But this time, with a slightly different flavor. Unlike the 2008 market crash, during this recent market downturn there has been an almost coordinated drop in value across the board, from oil and gas to plain vanilla equities, in the first part of this year.

In South Africa the mining sector is in a deep funk, notwithstanding the optimistic platitudes from the Mining Indaba conference in January 2016. Our economy is predominantly driven by commodity exports, representing 14 percent of GDP, and with China as one of our primary trading partners South Africa is at the mercy of the global commodity crisis.

Since mid-2015 the Chinese stock market has lost nearly a quarter of its value and the country will struggle to meet its lowered, but still ambitious, 6.5-7 percent growth target for 2016. The MSCI All–Country World Index, a broad benchmark of global stocks, slipped in February 2016 when it closed around 20 percent below its April 2015 level. This downturn, no doubt, has been leading investors and market observers to worry about a potential market crash in 2016.

Mines in decline: Share prices fall in 2015

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The result is a marked slowdown in all areas of mining activity in South Africa, from services to exploration and extraction. Correspondingly most corporate activity is down as a result of the significant drop in earnings and profit margins. Among the worst performers on the Johannesburg Stock Exchange in 2015 were mining groups, with Anglo American (which lost 65.5 percent of its share value), Glencore (60.9 percent loss), Anglo Platinum (43.3 percent loss) and South32 (40.7 percent loss) falling hardest. The protracted labor strike last year also stifled the mining sector, with low overall productivity in 2015 and the beginning of 2016.

This picture of doom and gloom does not mean that the world of mining in South Africa as we know it is coming to an end. However, it does imply that business won’t be the same in 2016. Here are the trends we need to get used to:

The ‘new normal’ growth rate of potentially less than 6.5 percent in China and hence a slowdown in South African commodities imports.

Europe, South Africa’s other significant trading partner, is caught up in a political quagmire on refugees and the structure of the union that will continue to impact its growth rate, and hence imports from South Africa.

Potential rate hikes by the US Federal Reserve will continue to have a dramatic impact on emerging market capital flows, which are mostly moving out of emerging markets into US treasury securities and other sectors in the US capital market, negatively affecting capital availability in the South African mining sector.

What does this all mean for mining in South Africa in 2016? The so-called exodus of investment capital could create opportunities to make uniquely lucrative deals, given the low valuations of most mining companies in South Africa, for those that are in for the long run. It is also an opportunity to optimize balance sheets to improve productivity and cash flow, and also for consolidation among key actors so they can more efficiently operate within the sector.

We will be seeing a lot of unbundling activity by largely diversified groups with far-flung asset classes such as Glencore and Anglo American. Groups will spin off business units and dispose of non-core assets: 2015 saw the split of South 32 from BHP Billiton and Optimum Coal from Glencore, and Anglo American has announced it will sell down or demerge Kumba Iron Ore. New players may find opportunities to enter the mining sector, assuming they are cash rich or have good access to the capital markets.

“Many firms, in particular the mostly black-owned and unlisted mining companies, will be put under stress, leading to significant consolidations.”

On the downside many firms, in particular the mostly black-owned and unlisted mining companies, will be put under stress, leading to significant consolidations, like those of Sibanye Gold and Aquarius Platinum, and Tegeta Exploration and Resources and Optimum Coal. This is due to the heavily leveraged structure of their deals and the absence of easy access to various capital markets in current conditions.  Nevertheless, it is not a prelude to a doomsday scenario as most debts are still in local currency, and the local markets are fairly liquid. This means that an efficient and high quality refinancing strategy should be the way forward.

Given the market gyrations of 2015 and 2016, it is understandable that most people are seeking signs of some form of stability. However, the focus should be on creating a coherent plan for putting cash to work in a market that little resembles anything seen before. We are likely to see a more pro-active engagement by the South African government, given the economic significance of the mining sector and the government’s need to avoid instability as result of an uncoordinated retrenchment. Against this backdrop, South African miners will have to make tough choices when it comes to their profitability, attracting and developing key skills, capital raising and capital allocation, and stakeholder engagement.