Standard & Poor's anticipates the 2009 operating performance of the global metals and mining sector to be much weaker with the potential for some improvement late in the year.
We think there's a good change that prices will rebound to a healthier level once demand starts to improve, although well below the peaks of 2007 and 2008, S&P Credit Analysts Marie Shmark, Michael Scerbo, Alex Herbert and Donald Marleau said.
We expect the first quarter of 2009 to be a continuation of the grim fourth quarter of 2008, with sector participants facing very low demand and pricing, as companies along the supply chain manage for cash, work off high-priced inventories, and continue to suffer from a lack of access to credit, they advised.
Many mining companies have not yet had time to adjust to the new market environment and those that have may not realize their results until later this year. This will weaken credit ratios this year, quite significantly for some, until companies decide upon and execute corrective actions which will begin to strengthen operating performance, the analysts said.
Based on current prices, we would expect significantly lower EBITDA and funds from operations, and we expect 2009 operating results to be well below those in 2008, they forecast. Negative ratings could result for companies that are unable to adjust their operations, cost base, and capital structures to reflect weaker circumstances.
Nevertheless, once metals inventories finally hit bottom or at least stabilize, and infrastructure programs begin to be funded, S&P suggests metals demand, capacity utilization, and mining company profitability should improve.
Of the 100 issuers rated by S&P in its global metals and mining portfolio, 30% of the issuers either have a negative outlook or are on CreditWatch with negative implications. Among these are Canadian miner Teck.
More specifically, we rate about 20 companies in the ‘B' category, with 15 of them rated ‘B-‘or below, the analysts said. These companies are particularly susceptible given their weak business positions, with limited flexibility to respond to the changes in business prospects, and often have high financial or operating leverage.
The analysts expect more capex spending cuts until improved global demand translates in stronger pricing and liquidity. However, companies that are financially stronger may perceive their competitors' capital spending reductions as good opportunities to undertake their own capital developments in readiness for the next upturn.
Meanwhile, M&A activity has dried up, the analysts asserted. A number of large transactions have been cancelled, most notably BHP Billiton's hostile takeover of Rio Tinto, they said. Even with many companies' stock prices down 60% or more and presumably stressed private equity firms looking to liquidate investments, buyers have not been stepping forward.
Reasons for the decrease in M&A activity include the unwillingness of sellers to accept bids at today's low prices in what is very much a buyer's market, reduced financing options, more cautious management teams, and the need by companies to restructure their operations before proceeding with a purchase, they said.
The lack of M&A activity has also created difficulties for companies which made debt-finance acquisitions during boom market conditions and have been unable to achieve meaningful and timely asset disposals to help reduce, such as Rio Tinto and Teck.
We expect potential large-scale transactions to continue to face persistent regulatory, shareholders, valuation, political and financing challenges, the analysts predicted. Still , as credit markets recover, we would expect a resumption of M&A and disposal activity with better capitalized companies seeking to improve their business positions by adding reserves, expanding geographic scope, or reducing their costs.
The analysts also advised that Obama Administration's most immediate impact on the U.S. metals and mining industry is the potential for significant infrastructure spending. However, they added, the Obama Administration could also introduce potential environmental legislation, in particular carbon limits, that could prove costly to coal companies, steel mills and aluminum smelters, which produce greenhouse gases.
The current bright spots in the mining sector are producer discipline including the copper, aluminum and nickel miners who are shutting down costly capacity. The analysts noted that the drop in commodity prices cut both ways. For instance, the decline of diesel, metallurgical coal, and iron ore prices will help lower costs for the heavy users of these commodities.
S&P also suggested that many companies will be forced to improve their capital structures and pull back from more aggressive growth strategies, which may eventually, improve credit quality. For example, very few U.S. metals and mining companies have near-term debt maturities, and many have retained cash on the balance sheet, prefunded pension requirements, and have large undrawn revolving credit facilities with few covenants, which will provide a cushion through the downturn.