05/07/2013 - 15:55

Mergers could lift struggling sector

05/07/2013 - 15:55

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Tough times in alumina may yet bring opportunity.

Mergers could lift struggling sector

Tough times in alumina may yet bring opportunity.

Not everyone is concerned about tough times in mining, with perfect conditions brewing for corporate deals, especially in nickel but perhaps more so in alumina.

Investment banks have a lot to gain from the looming shakeout of assets from the major players in mining – BHP Billiton and Rio Tinto.

Both companies have been actively seeking buyers for mines they no longer regard as ‘core’, with Rio Tinto’s unsuccessful attempts to sell its Argyle diamond mine an indication of what’s happening.

Two driving forces are behind what could become a period of significant change in mining in Western Australia.

The first, and most obvious, is the problem of low commodity prices and high domestic costs, which have shrunk profits.

The second is the promise made by new management teams at both BHP Billiton and Rio Tinto to focus on generating shareholder returns rather than investing in project development.

In BHP Billiton’s case the division most likely to be sold or closed is nickel, because even the falling value of the Australian dollar cannot mask the problems being caused by a nickel price seemingly stuck below $US6.50 a pound.

Selling assets is only one way of dealing with a problem, however. Another is to seek a merger with a nearby rival to achieve the benefits of shared costs (and perhaps greater marketing power), and that’s where alumina, the biggest industry in the state’s South West, might come into play.

Profits in the aluminium industry, with alumina the primary feedstock for production of the metal, have shrunk dramatically during the past 10 years; as has the relative importance of the major aluminium makers such as Alcoa, which controls three of WA’s four alumina refineries.

Earlier this month Alcoa suffered the indignity of having its debt downgraded by Moody’s Investors Services to ‘junk’ status.

A second measure of the once-great company’s decline was data from the New York Stock Exchange showing that Alcoa had become the stock in the Dow Jones industrial index with the greatest number of active short-sold positions – a measure of how many investors believe its share price will fall further in the future.

On the market itself, Alcoa’s shares have risen over the past few days but remain in the basement at around $US8, a price less than half ‘sum of the parts’ valuations put on the stock by investment banks.

In other words, breaking up Alcoa and selling its separate divisions could generate huge profits  – calculated by some to be more than $10 billion.

How does that affect the WA alumina industry? Well, BHP Billiton owns the Worsley refinery, and like the nearby Alcoa refineries it is struggling to earn profits.

Enter the dealmakers, because one of the suggestions being floated in financial markets is that Alcoa, BHP Billiton and a third player in the game, the ASX-listed Alumina Ltd (which owns a share in Alcoa’s operations), could all win from a merger of interests that created the world’s dominant supplier of alumina with enhanced pricing power.

A little more about what Alcoa might do to revive its shattered reputation (junk is an awful rating) may be revealed next Monday (July 8) when the parent company releases its second quarter earnings.

No-one in the financial markets is expecting a miracle, as can be gauged by the high level of short-selling in the stock, but there is pressure on management to do something more dramatic than simply demand suppliers cut their prices, which is what Alcoa did to its WA service providers in May.

Structuring a grand WA alumina deal would be tricky. Not only would government anti-monopoly regulators being watching, so would three groups of shareholders (BHP Billiton, Alcoa and Alumina) keen to see that they got value from an asset swap or asset sale.

But doing the tricky things is what investment bankers get paid for, and finding a way to reward shareholders by cutting costs and boosting profits is what management gets paid for. And the longer the aluminium and alumina prices remain stuck in the basement, the greater the pressure to do something to create value.

Coal conundrum

A SECOND mining industry facing tough times, and one close to the electoral base of Australia’s recycled prime minister, Kevin Rudd, is coal.

Politically unpopular with Mr Rudd’s minority partners in government, the Greens, coal is one of the biggest employers in his home state of Queensland.

Close to 9,000 direct jobs have disappeared from the coal sector in recent months, most of them in Queensland; and given that each direct job supports at least a further three indirect jobs, the extent of the pain being inflicted can be measured.

The challenge confronting Mr Rudd is that on one hand he has to keep the Greens happy by not being seen to actively support coal mining, while on the other he cannot allow tens of thousands of jobs to simply disappear, which they will thanks to the combination of low coal prices and high Australian taxes levied by multiple layers of government.

The squeeze on coal will get worse during the next few months thanks to an estimated 30 million tonne surplus of thermal (power generating) coal sloshing around in the global market, an excess of supply that will restrict the coal price to less than $US90 a tonne, and force more pit closures and job losses.

Face-off

LOSING Nelson Mandela will sorely test the stability of South Africa and its all-important mining sector.

Even more critical than the death of one man, however, is the potential for the unleashing of trouble in the mines, driven by trade unions that are demanding a greater share of the industry’s profits.

In one case a new group, the Association of Mineworkers and Construction Union, is already demanding double the basic pay for new underground workers, a cost the industry says it cannot afford and perhaps setting the scene for a post-Mandela showdown between black labour and white capital.


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