It is a good time to be a miner. On 24 August, BHP Billiton announced record annual profits of US$ 23.6 billion; the other majors are similarly raking it in. The talk is of a 20 – 25 year commodities “supercycle” driven by high demand from China that will keep prices high and profits booming. But despite the impressive numbers, some investors have sounded a note of concern.1
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Their worry centres on the way that some miners are spreading their risk. They point out that Rio Tinto earned nearly 80% of its record half-year profits from iron ore; Vale is also heavily dependent on iron ore having recently sold its aluminium business. Meanwhile, Anglo American still relies on its South African assets to generate 40% of its profits; its shares wobble every time a politician there mentions nationalisation (not an uncommon occurrence as readers of Barry Baxter’s regular column on southern African will be aware; see p. 8 for the latest).
The question of risk has typically been answered in one of two ways. BHP Billiton typifies the first approach, which comes down to geology. It has diversified its product offering, most notably by making sizeable investments in the potash and shale gas industries. Meanwhile, Peabody Energy – a company that depends exclusively on one commodity – is moving in the second direction and diversifying geographically, developing assets in Australia and China, as well as moving into the potentially vast Mongolian market.
By its nature, risk is not predictable and has recently appeared in seemingly unlikely places, as when Australia’s Government proposed a mining supertax. Indeed, swings in politics could become even more unpredictable than swings in commodity prices. With all of the cash currently flowing into miners’ pockets, further M&A activity is bound to follow. Miners should keep risk in mind when looking for acquisitions and avoid keeping all of their eggs in one geological or geographical basket.
1. “Geology or Geography”, The Economist (27 August – 2 September 2011), p. 50.