After a tumultuous year of speculation and uncertainty, Canadian mining and metals companies are facing three favourable market conditions that make them ripe for growth. Strong metals prices, low-to-average currencies in producing countries and relatively low input costs (especially for oil and gas and their derivatives) are resulting in significant cash flow.
This growth in cash flow, combined with low interest rates, growing economic confidence and the energy transition, has created renewed interest in mining stocks.
The return of bought deals and financing innovations such as “at-the-market” (ATM) distribution will also add to available funding for mining and metals companies. Recent regulatory amendments that have eliminated the sales cap and reduced regulatory requirements make ATMs a far more accessible and user-friendly way to tap the market for funding.
It will be up to each company to decide how to effectively deploy cash flow and capital from bought deals in a way that creates long-term value in a post-pandemic era. Each company will need to examine the opportunities available to them based on their assets, investors’ risk appetite, expertise, degrees of freedom and strategic needs. This game board and prioritization will be different for every company, but there are consistent themes that are applicable across the sector.
Infill exploration and operational improvements, for example, are easy to action with favourable risk profiles, but may not provide a sufficient increase in returns. Other opportunities such as merger and acquisitions or greenfield projects can be much riskier but secure a higher return and provide additional strategic benefits, such as re-rating or political risk diversification.
We’ve seen the sector lean towards transactions, with an increase in M&A activity since July 2020 and stronger deal making expected on the horizon. According to the EY Global Capital Confidence Barometer, nearly half of respondents are planning acquisitions in the next 12 months in preparation for a different market landscape as the economy starts to reopen.
On the other hand, some miners may look to divest underperforming, undersized or neglected assets into an exuberant market. Others may consider diversifying to meet anticipated demand arising from global growth and the energy transition. Demand from renewable energy and storage could require significant investment in the next decade, with producing assets in lithium, cobalt, graphite, nickel, copper and even aluminum benefiting from greenfield pricing in these sectors.
Defining the right method to return capital to investors
Ideas on what to do with capital will also include suggestions on the right approach to return capital to investors. This will require navigating the typical debate: dividends or share buybacks?
Dividends pull in generalist investors and can provide a signal that the company anticipates positive cash flow. However, investors typically want to see continuous increases over time that may not always be feasible to meet if the business experiences unexpected costs, leading to higher shareholder turnover. Dividends also impose taxable events, which may not be a big disadvantage for Canadians, but could pose a challenge for foreign investors.
That’s why share buybacks are increasingly seen as a more favourable approach to return capital. Buybacks are currently the most common and highest value capital payout policy across all public markets. Recent studies indicate that companies with active share buybacks achieve higher excess returns in both up and down markets, and across large, mid and small-cap segments within North America. Share buybacks can also be more tax efficient with the benefit coming in liquidity and capital gains that can be realized at the timing of the investor’s choosing.
Though, cyclical companies must keep in mind that when they have capital for buybacks may not always align with the best time for buybacks. Buybacks work best when management’s view of the company’s value suggests shares are being undervalued by the market.
Responding to rising shareholder focus on ESG
While mining companies are increasingly under pressure to improve shareholder returns, climate change and diversity are driving a rise in non-financial activism. Capital returns to shareholders will help boost short-term returns, but long-term value creation – beyond financials – will be key to earning shareholder approval. In analyzing the game board of options, miners should use non-financial metrics to prioritize capital allocation to help secure their future and demonstrate this value by focusing on:
• Greening their brand and reducing their carbon footprint;
• Greater transparency, board quality and long-term strategy;
• Broader community commitments in areas of respect, equity and resource management; and
• Embracing digital transformation.
Jon Wojnicki is a partner and co-leader of EY Parthenon Canada, based in Toronto. For more strategy insights, visit www.ey.com/en_ca/strategy