Shares in Anglo American (LSE: AAL) and Lonmin (LSE: LMI) have been some of the market’s worst performers this year. In fact, Anglo holds the undesirable accolade of being this year’s worst-performing FTSE 100 constituent.
Unfortunately, it looks as if these two disgraced miners will continue to underperform during 2016 as they struggle to reorganise their operations and generate cash to pay down debt in an increasingly hostile environment for the mining industry.
Plenty of mistakes
Anglo and Lonmin’s troubles didn’t emerge overnight. For years, these two companies have been mismanaged, have lacked capital discipline and haven’t been reinvesting enough to keep things running smoothly.
For example, Lonmin’s troubles go back almost 10 years to when the company embarked on a costly and ineffective programme to introduce more mechanised mining to its South African mines. This ill-fated modernisation drive left Lonmin with plenty of debt and soured relations with its workers. A rights issue followed and then the financial crisis hit the company. It was forced into another rights issue during 2012. Including the cash raised from investors via the latest rights issue, Lonmin has raised just under $1.3bn from investors since 2009.
But despite these cash infusions, the company has been unable to remain consistently profitable. Lonmin has earned less than $600m from operations since the financial crisis and management’s decision to slash capital spending – in order to conserve cash – means that the group’s operations are suffering from chronic underinvestment.
And while Lonmin’s operations are suffering from underinvestment, Anglo’s balance sheet is in tatters after years of frivolous spending by management.
Lack of capital discipline
Anglo’s troubles can be traced to the company’s ill-fated expansion into the iron ore industry.
The company is the majority owner of Kumba Iron Ore Ltd, Africa’s largest iron ore producer. It also owns a key operation in Brazil, the troubled Minas-Rio asset. This went into production last October, about five years late and almost three times over its original $2.6bn budget.
Anglo’s South African iron ore operation, Kumba, needs to sell its iron ore at a price of $50 per tonne or more to remain profitable. Unfortunately, the spot price of iron ore slumped to an all-time low of $38.20 a tonne last week, and there’s nothing to indicate that the price will recover any time soon. Indeed, according to investment bank Morgan Stanley, the iron ore market will peak at 107.4 million tonnes in 2018 and persist through to 2020.
Kumba’s management has responded by saying that the company will cut production by a third to cope with the slump. But the damage to Anglo’s balance sheet and reputation has already been done. The company has now been forced to embark on one of the largest restructurings ever seen in the mining industry. Anglo is planning to cut 85,000 jobs, sell or shut 60% of its assets and will take an impairment charge of up to $4.7bn due to “weaker prices and asset closures”.
This dramatic overhaul will take time, and when it’s completed, Anglo will be almost unrecognisable compared to the mining giant it was only a few years ago.
