With persistently low shareholder returns and a dim outlook for the sector, mining companies must dig deeper in their productivity efforts, while also being proactive in seeking other growth opportunities, business strategy advisory company Boston Consulting Group (BCG) research finds.

Creating value remains an uphill battle for mining companies. Although unit costs have stabilised, falling commodity prices and slowing production have made it hard to deliver positive total shareholder return (TSR) and current productivity programmes are running out of steam.

This is according to BCG’s new report, entitled ‘Value Creation in Mining 2015: Beyond Basic Productivity’.

The report examines the TSR for 101 mining companies from 2010 to 2014. Over that period, the median TSR of the sample was 18%. These results contrast sharply with those of the first decade of the millennium (2000 to 2009), when the global commodity price boom fuelled growth in profits.

Apart from the decline in commodity prices, BCG identifies two fundamental factors underlying the reversal of fortune: rising production costs (and, in turn, declining margins) and investors’ waning appetite for mining stocks.

The report also found that the industry’s earnings before interest, taxes, depreciation and amortisation, or Ebitda, margins fell from 42% in 2010 and 2011 to just 33% in 2013.

“The margin squeeze has been uneven across different countries. Between 2010 and 2013, unit costs increased by 6% to 10% in Australia, about 12% in Peru, and between 14% and 15% in Chile.”

BCG notes that gold and coal companies were particularly hard hit between 2010 and 2014.

The report points out that the coal sector declined, owing to the rising abundance of natural gas and oil supplies which depressed energy prices, including the price of coal.

Slowing economic growth in China dampened demand for both metallurgical and thermal coal. Additionally, BCG says that heavy debt loads put downward pressure on valuation multiples and the impact on US coal companies proved particularly harsh as several now face financial difficulties.

The price of gold declined by about40% to around $1 200/oz by the end of 2014 and continued to decline this year to around the $1 100/oz level by mid September this year.

Further, the report highlights that unit costs, though stable following a decade of increases, still exceed 2009 levels.

“Mining companies’ productivity programmes are working, however, not at the pace required,” the report notes.

The report cautions that companies cannot rely on their existing productivity measures to improve TSR.

“Achieving further cost cuts will become increasingly difficult as the more visible opportunities begin to disappear,” says BCG partner and report coauthor Gustavo Nieponice.

He adds that, given the uncertain economic outlook, companies cannot rely on an uptick in commodity prices as a lever for recovery.

The report continues by pointing out that, to rejuvenate their fortunes, companies need to take an end-to-end approach to productivity and tackle three performance dimensions simultaneously. These include the efficiency of physical assets, the effectiveness of management systems and the level of people excellence.

BCG says this is best accomplished through a “triage” approach that targets the weakest areas first.

“Companies often focus on negotiating lower rates and better payment terms as a way to gain efficiencies with contractors,” notes BCG principal and report coauthor Thomas Vogt.

He says, in doing so, they overlook many other opportunities to improve productivity within these relationships.

BCG states that it has identified eight value levers, including contract demand management, contract consolidation, contract scope break-up and contractor productivity enhancement, which have enabled companies to streamline, create efficiency and save substantial portions on yearly contract fees.

The company says that a holistic approach to contractor management also includes using data and analytics to select, manage and compensate contractors, as well as developing internal capabilities to optimise how contractors are used on site.

Value Creation Beyond Productivity

Nonetheless, BCG acknowledges that productivity alone is not the answer to value creation.

The report identifies three important future-orientated strategies for value creation beyond productivity.

It says, firstly, companies should reassess their project pipelines (projects proposed before the financial crisis and those already under way), weighing them in light of new technologies and the capital expenditure required to sustain existing operations.

Secondly, the report notes that, owing to current low valuations, companies with the means and capability should be opportunistic about their mergers and acquisitions (M&A) strategies.

And finally, the report states that companies need to look closely at new technological developments from automated equipment to real-time data and analytics to improve overall operational efficiencies.

“Ultimately, productivity is not a strategy as mining companies need to immediately start to replace depleting resources and drive long-term profitable growth either within the existing portfolio or through M&A,” says BCG partner and report coauthor Alexander Koch.

This is the fourth report on value creation in mining spon- sored by BCG’s industrial goods practice. The report forms part of BCG’s Value Creators series, which uses BCG’s proprietary methodology to disaggregate the sources of value creation among top-performing companies throughout leading industries.