Since 2011, the mining industry has been in disarray, as bloated capital spending budgets and sliding commodity prices have hit profits and cash flows hard. However, miners such as BHP Billiton (NYSE:BBL), Rio Tinto (NYSE:RIO), and Vale (NYSE:VALE) are starting to get their act together, slashing capex, closing inefficient projects, and targeting quality over quantity, which is a huge shift for the resource industry and brings to an end years of spending excess.
Ramping up production
As I have already mentioned, miners are now targeting quality over quantity, and this is really starting to show through in production reports. For example, BHP's iron ore production was up 16% for the three months ending December, and the company's production of metallurgical coal used in steelmaking also hit record levels in the second half of last year. What's more, the company is increasing its oil and gas production from shale oil assets within the United States; it expects these assets alone to generate $3 billion in cash annually for the company by 2020. These record production figures come at a time when BHP is slashing spending. In particular, BHP is planning on cutting capex for 2014 to only $16.1 billion, down from $22 billion in fiscal 2013.
And it's not just BHP. Rio also announced record production of iron ore, bauxite (used in the production of aluminum) and thermal coal during 2013. Meanwhile, the company is planning on cutting its capex spending by 20%, to only $11 billion for 2014, and then a further 20% for the year after, to only $8 billion for fiscal 2015.
Sadly, Vale has not reported similar output increases, but the company is planning on cutting capex, to $14.8 billion for 2014, the third year of declining spending for the company after reaching a high of $18 billion during 2011.
All in all, these cuts are designed to increase cash flow and, over the long term, improve shareholder returns. For example, if BHP sticks to its capital spending budget, and generates the same value of cash from operations as it did during fiscal 2013, the company's free cash flow will be in the region of $2 billion during 2014. This will be the first time that BHP will report a positive free cash flow in two years. In addition, if Vale sticks to its capital expenditure forecast for 2014, the company should be set to generate nearly $2 billion in free cash flow for fiscal 2014.
What's more, according to Andrew Mackenzie, CEO, the company "remains committed to actively manage our portfolio for value...This strategy leaves us well positioned to deliver a substantial increase in free cash flow and higher returns to shareholders."
This implies that after several years of lackluster returns, commodity investors might start to see better returns.
Pollution is helping to drive profits
Aside from these self-help initiates, these three miners are set to benefit from an interesting development in their biggest market: China.
You see, to combat a devastating smog currently engulfing much of China, the Chinese authorities have imposed strict emission limits on many industrial companies. This includes steel producers. As a result, there has been a rise in the demand for 'lump,' a higher quality iron ore that doesn't require sintering before being used in steel production. Sintering is essentially turning lower quality iron ore into lump, but the process is energy-intensive and a major contributor to pollution. The demand for lump has meant that the lump market has seen somewhat of a bubble recently, with prices, in comparison to standard ore, almost doubling. Further, some analysts believe that this is only the start of a bull market for lump as more sintering plants close down in China's drive to combat pollution.
Overall, this is great news for BHP, Rio, and Vale, as they produce some of the best quality iron ore in the world. Meanwhile, lower-quality producers are likely to suffer, and this could see a decline in supply of iron ore, great news as the market could be considered to be oversupplied.
In conclusion, the mining industry has finally started to turn around and is now concentrating on quality over quantity. Over the next few years this should mean that miners start to become cash flow positive again, and investors should benefit. Still, although these changes are under way, the sector has plenty of catching up to do.