TORONTO (miningweekly.com) – The top concern among companies tracked by the Ernst & Young (EY) Canadian Mining Eye team over the third quarter was capital allocation and capital access.

The result reflects the harsh fiscal climate, EY’s Canadian mining and metals transactions leader, Jay Patel, told an audience at the Canadian Institute of Mining, Metallurgy and Petroleum’s Management and Economics Society last week.

The next four top concerns were: margin protection and productivity improvement, resource nationalism, social licence to operate, and skills shortages.

“But I don’t think resource nationalism has dropped in severity and, in my mind, it’s going to get worse as governments focus on the past metals price increases and become more egregious [in their take from the sector],” Patel said.

“For juniors, the main focus will be about reducing the cash spend in order to survive the downturn. The risk at this end is pretty high and investor sentiment has moved toward risk aversion, which means even less capital,” he said.

“Less capital then affects capital allocation,” he added. “And this is a dilemma not just for juniors but for the majors and the midtiers too.”

The impact is evident with the majors evaluating project viability and determining which areas they should focus on most. Their primary goal is to “repair their balance sheets, which became bloated in the past,” Patel said.

“We also feel that people took their eyes off the productivity side during the years of the ramp-up and there’s room for improvement here,” he said.

“Companies will become inwardly focused, concentrating on the assets already to hand rather than making [further] acquisitions,” he added. “The theme of the day will be low risk. It’s the low-risk assets that will probably get [preference in] funding.”

STORM WATCH

EY continues to track the storm affecting the TSX and TSX-V and the resultant impact on market capitalisation, with the junior sector bludgeoned most.

“Roughly 900 companies have a market cap at or below $5-million and, of them, about 400 have a market capitalisation at or below $1-million,” Patel noted.

EY’s Canadian Mining Eye index tracks the performance of 100 TSX- and TSX-V-listed mining companies. Over 2013, the coal and consumable fuels group was the index’s weakest performer.

“This is not surprising: shale gas in the USA has had a huge impact over the past few years, with roughly 50 coal mines closed. The only way thermal coal producers will survive is to either look at metallurgical coal or gas assets,” he said.

Gold, silver and streaming companies on the index have also struggled, reflecting the pressure on precious metals prices across 2013, particularly so for gold. “Is [gold] going to be soft for a little while? Yes I think it will be,” Patel said.

The index’s base metals-focused companies, and those with diversified portfolios, have also had to contend with stilted price performance. By comparison, the diamond-focused companies have performed well.

On a brighter note, EY has noticed that costs are starting to be brought down. “We’re seeing more availability of drill rigs and attendant drill costs are coming down too.  In addition, contract mining costs are coming down as some companies are able to renegotiate,” Patel said.

Further cost reductions can be expected as more marginal operations and projects come off stream, creating a buyer’s market for many goods and services.

The problem of investors buying and selling shares within shorter and shorter timeframes remains a pressing concern. The industry must do more to educate their shareholders on the long-term nature of bringing projects to fruition and mining in general.

“Shareholders need the education to understand that this is a long-term business and that you need to hold for the longer term,” Patel said.

Holding investor days for shareholders is an excellent means of emphasising this. “For example, Dow Chemical holds three investor days where the company takes analysts and shareholders to every part of their business, saying: ‘here’s what we’re doing’. I can’t say that I see many mining companies doing this,” Patel said.

However, companies must also learn to focus their efforts on project or operational development without constantly worrying about what shareholders might want. “At some point people have to stop and say ‘here’s what we’re doing to best manage our assets’,” Patel said.

OPPORTUNITY KNOCKS

As part of the drive to balance the books, noncore assets will be increasingly divested by the majors. This affords the midtiers, in particular, an excellent opportunity to make acquisitions.

“We think the time is right to seek out mergers and acquisitions (M&As) and some of the mining companies are doing this. One really interesting example has been Agnico Eagle, which recently did about five transactions for a total of $66-million.”

But both buyers and sellers are far more cautious in their approach. “We are seeing a higher level of prudence; the sellers aren’t just walking away with giveaway prices, while buyers are also being cautious,” Patel said. “This will be the prevailing mentality in the long run, which we think is pretty healthy.”

Overall, M&A will remain comparatively muted because of the market conditions. “Transaction activity in the next 12 to 15 months will be quite subdued. Only those transactions that have to happen, will happen,” Patel said, adding that some acquisitions will be opportunistic in nature.

“For an opportunistic M&A, the seller has to be distressed and the asset has to be a good-quality one. It’s got to be low-cost asset, with a medium to longer life and in a less political risky jurisdiction,” he added.

EY believes that the level of risk-sharing and resource pooling will also continue to grow. “We think risk sharing will be a theme in the sense that asset owners will want to share their asset with other players seeking to share risk,” Patel said.

“The other thing we are seeing is the increased interest of private capital in the mining sector, although the private capital investor should ask: ‘Do I really have the wherewithal to go into a long-term industry and do I have the knowledge to do it?’”