How to do Business Analysis of Mining Companies

The current article aims to highlight the key aspects of the business of mining companies like coal, iron ore, limestone, lignite, zinc, chromite, bauxite, copper etc. After reading this article, an investor would understand the factors that impact the business of mining companies and the characteristics that differentiate a fundamentally strong mining company from a weak one.

Key factors influencing the business of mining companies

1) No pricing power for mining companies due to non-differentiable commodity products leading to the intense price-based competition:

Mining companies produce mineral ores, which have standard specifications based on metal content, type of ore etc. As a result, a customer can easily replace the ore of a given specification provided by one miner with another miner.

Due to such non-differentiable, commoditized products, miners do not have any pricing power over their customers. If any miner attempts to charge a premium over the prevailing market price, then its customers can easily switch suppliers to avail lower prices without any significant impact on the quality of metal produced by them.

As a result, every mining company, however big or small, must accept the market price.

Metals and mining rating methodology by Scope Ratings, Germany, October 2022, page 7:

given the commoditised nature of the industry, even the largest players are price-takers.

Moreover, most of the mineral ores are routinely transported by sea over long distances in international trade. As a result, miners based in one country easily supply customers across the globe. This makes the mineral prices trade on global price parity because a surplus or deficit of mineral ores in any country can easily be met by imports.

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domestic prices would have strong linkages with international prices. Given the multiplicity of factors determining global demand-supply balance, the threat of imports adds to volatility in the domestic prices.

Therefore, almost all the mineral ores follow one global price.

Global Methodology for Rating Companies in the Mining Industry by DBRS Morningstar, page 5:

most commodities are considered to have generally global markets with one price

As a result, in order to gain customers’ business, the only tool available to miners is charging a lower price than competitors. It leads to intense price-based competition in the mining industry.

Rating methodology for the mining industry by Standard and Poor’s (S&P):

Metals and bulk commodities have standard specifications, competition is based almost exclusively on price, and even the strongest mining companies cannot differentiate their products to get better or more stable pricing.

Therefore, it does not come as a surprise that mining companies have no control over the prices of their products.

Criteria for the mining industry by CRISIL, February 2021, page 16:

Mineral prices are affected by factors that, generally, are beyond the control of a producer.

In addition, due to the global price parity of most minerals, mining companies face a significant foreign exchange fluctuation risk even though they only sell to domestic customers. This is because the price of their products is based on global prices, which factor in foreign exchange movements whereas all their costs are incurred in domestic currency.

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The production cost of a domestic miner is incurred primarily in the domestic currency, while selling prices are linked to the exchange rate, being typically paired with the international benchmark reference prices.

2) Capital-intensive business with a lot of time and resources required for mine development:

Mining companies need to spend a lot of money and time to develop mines i.e. to be able to extract ore from an area proved to have minerals. Many times, it may take up to 10 years for a company to start extracting ore from a mine after identification of the presence of ore.

Metals and mining rating methodology by Scope Ratings, Germany, October 2022, page 3:

A new mining project can easily take over 10 years from the discovery of an ore deposit to commissioning.

Mining companies have to make large investments to start ore production from a mine as they have to undertake large amounts of land acquisition, relief and rehabilitation of population, prepare the area for ore extraction, and put in large amounts of machinery for ore extraction and transportation.

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mining industry is capital intensive, with the need for large upfront investments before production is achieved.

However, even after making a large investment at the start of mining operations, the investment requirements do not come down. Once the easily extractable ore is taken out, then the company has to spend more money to extract further ore. For example, once ore from the open cast area is extracted, then the company may have to develop underground mines, where it is expensive to extract the ore.

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Underground mining is more complex and expensive than open-pit mining, and more at risk of unforeseen geological conditions, operational disruption or mine accidents.

As the operations of the mine continuously deplete the existing ore reserve in the mine, the mining company has to continuously find new ore reserves to maintain the scale of its business operations. This process of finding and developing new reserves requires further investment, thereby, increasing the capital intensity of mining operations.

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Mineral reserves are considered to be depleting and require replenishment, which often means ongoing significant investment to maintain productive capacity.

Even after the closure of a mine, the mining company has to spend resources for the restoration of the natural environment, which adds to the capital intensiveness of mining operations.

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Mine decommissioning is often subject to costly closure and reclamation requirements.

In fact, the large requirement of capital to establish and run mining operations as well as a very long lead time to develop new mines presents a significant challenge to the new entrants in the mining operations and in turn, acts as an entry barrier to new players.

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The industry’s high capital-intensity and long lead times for new investments provide for substantial barriers to entry, particularly in the upstream segments.

In terms of high capital requirements and greater risks associated with operations, mining companies are usually compensated by high operating margins.

Global Methodology for Rating Companies in the Mining Industry by DBRS Morningstar, page 5:

Mining industry operating margins are higher than average industry margins because of high capital intensity and higher-than-average investment risk, which lead to a high cost of capital.

3) Cyclicity in the business of mining companies:

The mining industry is highly cyclical i.e. it goes through alternate phases of boom and bust. In fact, as per Canadian credit rating, DBRS Morningstar, mining is one of the most cyclical industries in the world.

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Given the volatility of commodity prices and the sensitivity of demand to economic cycles, mining is among the most cyclical of industries

The performance of mining companies is highly correlated to the phases of the general economic cycle primarily due to two reasons.

First, most end-consumers of the mining industry depend on the performance of industries like automobiles, infrastructure and construction, real estate etc., where demand is highly correlated with the state of the general economy.

The demand peaks at the top of the economic cycle leading to an increase in ore prices. Whereas the demand bottoms out at the end of the cycle leading to a decline in ore prices. It leads to the volatility of the earnings of mining companies.

Metals and mining rating methodology by Scope Ratings, Germany, October 2022, page 6:

The metals and mining industry is highly cyclical. The demand for products is closely linked to general economic growth rates. Many end-user segments for metals and mining products are cyclical, including automotive, capital goods, building materials, and engineering and construction

The other factor, which significantly increases the impact of cycles on mining companies is the long lead time in developing/expanding mines. When demand for minerals is high, then mining companies announce capacity expansions. However, due to the long development time, when the new mines become operational, by that time, the economic cycle would have turned into a recession.

This leads to a situation of overcapacity of mining when the demand is low. As a result, the revenues and profit margins of mining companies decline significantly.

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When mineral prices are at their peak, entities have the resources to channelise higher funds in greenfield or brownfield mine expansions, supported by the confidence of their buoyant cash flows. However, given the long gestation period in the mining business, there always exists the possibility that by the time the new capacity is ready, a slowdown in demand from end-user industries can lead to a supply glut.

An example of such a situation when the demand for minerals declined at the time new mining capacity became functional was seen in 2015 in the iron ore segment. At that time, many global mining companies had expanded their capacity to supply to growing Chinese demand. However, when the mining capacity became functional, the demand from China declined leading to a crash in iron ore prices.

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Global iron ore miners like BHP Billiton, Rio Tinto, Vale, and Fortescue Metals had heavily invested in ramping up mining capacities over the last few years, but with Chinese steel demand growth slowing down from CY2015 onwards, it had resulted in a sharp correction in seaborne iron ore prices.

Mining companies face a dual impact on their business performance due to commodity cycles. On the one hand, their revenues see wild fluctuations due to volatile commodity prices.

On the other hand, cyclical volatility in crude oil prices leads to fluctuations in their costs. This is because, a significant cost of mining operations is running costs like fuel (diesel), lubricants and tyres of mining vehicles whose cost is dependent on crude oil prices.

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Diesel, lubricants, and tyres/tubes for heavy earth moving machinery form key cost elements in mining operations. Their prices depend on crude oil prices. Therefore, crude oil price is an important driver determining the profitability of mining entities.

As a result, the business performance of mining companies is highly volatile. In fact, the performance is so fluctuating that the Canadian rating agency, DBRS Morningstar has stated that it is unlikely that any mining company will ever achieve an AA rating.

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Given the volatility of the industry, it is highly unlikely that a mining company will achieve an issuer rating in the AA range

In order to reduce the impact of cyclicity, many times, those mining companies that enjoy a monopoly or a large market share/oligopoly resort to curtailing the supply of the minerals to create scarcity and increase the prices of minerals. It usually happens in the case of mining companies involved in diamonds and platinum groups of metals.

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pricing volatility can be moderated in certain sectors where production is concentrated in the hands of a leading producer or oligopoly of producers that can voluntarily reduce production to maintain pricing stability (e.g., diamonds or platinum group metals).

4) Operating efficiency, being a low-cost producer is the biggest advantage in the mining sector:

As mining companies produce non-differentiable commodity products and do not have any pricing power; therefore, the only way for a mining company to perform better than its peers is to be as low-cost a producer of ores as possible.

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Operational efficiency is a critical factor that determines the profitability of mining entities, especially given that prices are often linked to global demand-supply forces, leading to limited pricing power for domestic miners.

Criteria for the mining industry by CRISIL, February 2021, page 16:

A low cost position is important in an industry where producers have limited pricing flexibility.

Due to the cyclical nature of the mining business, revenues and profits fluctuate significantly. Especially, during down phases, the financial position of mining companies comes under a lot of stress. Losses during the down phases of the cycle may force the closure of cost-inefficient mines.

Rating methodology for the mining industry by Standard and Poor’s (S&P):

…high-cost mines may be closed in a downturn.

Low-cost mining companies are able to remain profitable even during the cyclical down phases. Therefore, such companies are able to survive tough times much better than high-cost producers.

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Moreover, entities at the lower end of the cost curve (first and second quartiles), during pricing downcycles, exhibit superior ability to adapt to dynamic pricing scenarios, while continuing to remain profitable.

In order to be low-cost producers, mining companies put many strategies in place to be operationally efficient. However, there are many aspects of their operational costs, which are outside their control like the type of ore, its quality, whether it produces valuable by-products that can add to the income, whether the mine is an open pit or underground and the level of financial levies by the govt.

Metals and mining rating methodology by Scope Ratings, Germany, October 2022, page 10:

The cost position of a mine depends largely on the ore grade and presence of valuable by-products in the ore; the size (mine life); the depth and complexity of the ore body; the presence of water, electricity, and transport systems near the mine; as well as tax and royalty regimes.

Nevertheless, mining companies take many steps to bring in operational efficiencies and reduce the cost of operations like increasing mechanization and automation.

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Additionally, a greater intensity of mechanisation through enhanced technology absorption helps increase the operational efficiency and production throughput, giving the entities an edge over their competitors.

As mining operations involve the movement of large quantities of minerals; therefore, transportation expenses form a significant cost. Transportation cost via railways is lower than road transport. Therefore, mining companies with railway transport infrastructure at the mine are able to save on costs and build a competitive advantage.

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For longer distances, railway connectivity having dedicated siding is viewed favourably over evacuation through road, given the cost competitiveness of rail transport over road transport.

Energy costs are another important cost. Therefore, mining companies with sources of low-cost power like captive plants or long-term power purchase agreements (PPAs) have an advantage over those mining companies that must buy power in spot purchases.

Criteria for the mining industry by CRISIL, February 2021, page 17:

CRISIL Ratings also looks at the ease of access to low-cost energy and reviews whether or not it is purchased under long-term contracts.

As demand for minerals fluctuates significantly over an economic cycle and costs of mining operations are relatively inflexible; therefore, many mining companies outsource entire or partial mining operations so that they can reduce the fixed expenses. Such arrangements are especially helpful during down phases.

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This risk-sharing model through various degrees of outsourcing is beneficial for mining entities especially in periods of low demand, given that it provides greater flexibility in reducing costs during such periods.

Nevertheless, established mines usually are more operationally efficient because there are lower chances of disruptions of operations than newly developed mines.

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longer the relative life of a mining operation, the more stable its production and its ability to manage and maintain its profit margins.

Similarly, mines with long-term supply arrangements with their customers are more operationally efficient as they have a more stable visibility of demand and can plan their production accordingly.

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presence of long-term supply arrangements is viewed favourably, as it gives a steady revenue visibility

4.1) A continuous addition of cost-effective mineable reserves is essential for companies:

As discussed above, mining activity leads to the depletion of existing reserves of companies. Therefore, companies need to continuously add to their mining reserves to maintain their scale of business operations.

Whenever a company announces new mining reserves, their cost-effectiveness must be kept in mind. This is because if subsequently, extracting those reserves proves to be high-cost, then it might reduce the profitability of the mining company.

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The replacement of mined-out reserves is another important consideration and must be monitored for the conversion cost of resources to reserves, as well as the impact of the new reserves on the operating cost structure of the mining operations.

As it is very difficult to assess the exact ore grade and the costs needed to successfully extract it; therefore, many times, mines face negative surprises where the cost to mine the reserves might be so high that it makes them economically unviable.

Metals and mining rating methodology by Scope Ratings, Germany, October 2022, page 10:

Ore bodies are not always uniform and well surveyed. This can result in surprises, such as sudden changes in ore grades and characteristics, which may require costly changes in mining or ore-processing methods, or in a worst-case scenario render a mine uneconomical.

5) A large scale of mining operations is a competitive advantage:

Mining operations need to be operationally efficient producers because their products are non-differentiable commodities without any pricing power. In such circumstances, a large size of operations brings in several advantages.

Large mining companies benefit from economies of scale in their operations as it spreads fixed overheads over a large quantity of ore and thereby, reduces the per tonne cost of production. A large mining company can also adjust its production better in downturns and maintain supplies to its customers.

A large size also enables the mining companies with greater bargaining power with their suppliers leading to lower costs.

Metals and mining rating methodology by Scope Ratings, Germany, October 2022, page 7:

Benefits of a strong market share typically include economies of scale, greater flexibility to adjust overall production and capacity to fluctuations in demand, better control over distribution channels, greater purchasing power with key suppliers

Large-sized mining companies have relatively stable operations and are able to enter into long-term take or pay contracts with large customers and therefore are able to have better visibility of revenue and profitability than other smaller peers without such contracts with their customers.

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Size also implies a larger number of operations that can reduce the potential for material production outages disrupting operating cash flows. The relative ability to be a price setter compared with a price taker in the markets that a company serves (i.e., annual, quarterly, or other pricing contracts as opposed to spot-market pricing)

Moreover, a large mining company is in a better position to withstand cyclical downturns as it might have more diversified operations, which helps it reduce the impact of cyclicity. In addition, it comparatively has easier access to financing that helps it maintain expenses when cash flow from operations declines.

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A mining entity with a larger scale is associated with a greater ability to withstand commodity down-cycles, given their advantages in areas like a) product-market diversity (allowing them to mitigate revenue loss in specific businesses), b) greater pricing flexibility on account of cost-efficient production practices derived from economies of scale, as well as c) easier access to capital.

6) Diversification in operations is a big competitive advantage for mining companies:

To reduce the impact of cyclical fluctuations on their business model, mining companies attempt to diversify their operations along different lines like different minerals and grades of ores along with diversification in customers, geographic location of mines, exports/domestic markets etc.

Diversification helps to reduce volatility in cyclical industries because different commodities, economies, and customers may not suffer from downcycle at the same time. Therefore, the financial performance of a diversified mining company might be relatively stable.

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Moreover, mining entities with multiple minerals in their portfolio and serving a broad range of markets hedge risks associated with volatility in individual commodity prices…diversified client profile to be a positive, as it helps mitigate revenue loss in the event of a loss of a specific client…a balanced share between domestic and export sales is therefore viewed favourably.

Companies can achieve meaningful diversification when they have different minerals contributing at least 10% of revenues.

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a diversification unit is generally defined as a commodity that contributes at least 10% to revenue during an operating period

Companies that produce 3-4 different commodities, whose demand and supply dynamics are relatively independent of each other can have significant diversification benefits.

Rating methodology for the mining industry by Standard and Poor’s (S&P):

a company with meaningful EBITDA contribution from three or four commodities with demonstrably independent price and volume drivers could be viewed as well-diversified.

If a company has its mines spread across many different regions and countries, then it is relatively protected from natural, operational and regulatory disruptions linked to any one region or country.

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A geographically diversified asset base partially mitigates risks associated with revenue volatility due to unforeseen mine-specific production disruptions like floods/natural calamities, labour unrest, and regulatory actions.

Nevertheless, companies with a single mine are also relatively protected from sudden disruption if their single mine has many operating faces or separate mining pits.

Criteria for the mining industry by CRISIL, February 2021, page 17:

even a single mining company can achieve diversification if it operates one mine with multiple operating faces within the same pit, or a number of separate pits within one mine.

7) Integrated mining companies have competitive advantages:

Apart from the said diversification across minerals, customers and geographies, many mining companies go for integration of operations to create competitive advantages.

A vertically integrated mining company, which produces mineral ores and also produces finished metal using its in-house ore enjoys better profit margins because it can capture the value-addition across the value chain. Moreover, if the mine and the metal plants are located nearby, then it can save on transportation costs and bring in further operating efficiencies, which lead to higher profit margins.

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Complete vertical integration allows companies to capture the full value chain for the finished products being sold, potentially reduces transportation costs

Integration of operations by mining companies into metal production (downstream activities) helps them reduce the impact of cyclicity when compared to standalone mining companies. Another factor that reduces the impact of cyclicity is the presence of customers of downstream products in many different industries, which brings in an element of diversification in the business.

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Although downstream businesses also suffer during periods of stress, such businesses display relatively lower cyclicality compared to pure mining businesses. Besides, since different downstream products find applications in different industries, forward integration into more value-added products enables an entity to lower its dependence on any particular user industry or customer.

8) Very high regulations on the mining industry and associated political risk:

Mining operations involve extracting national resources, which cover large land areas. Both aspects expose mining to very high political and regulatory interventions.

Mining companies need numerous regulatory approvals before they are able to start work on the development of the mine.

Rating methodology for mining entities by ICRA, June 2021, page 3:

mining is a highly regulated business, requiring multiple approvals from various Central and State Government agencies…Any deviation in conformance with applicable mining laws can not only result in production disruptions due to bans, but also may lead to hefty penalties imposed by the Government.

As the mining process is effectively taking out national resources for profits; therefore, governments put numerous levies including taxes, cess etc. on mining companies to enhance the national and local income.

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Mining entities have to pay a multiplicity of taxes and duties to the Central and State Governments. This includes royalty, contributions to district mineral foundation (DMF) and national mineral exploration trust (NMET), GST, cesses, and export duty, among others. Additionally, entities that have won mines through auction have to fork out auction premiums

These high regulations and taxes on mining companies are not limited to India. In fact, it is a global practice applicable to mining companies everywhere.

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mining industry is characterized by…(4) a high degree of regulation that is concerned with environmental, health, and safety compliance…(6) often-high political risk, ranging from changes in taxation or royalty frameworks to difficult licensing processes,

In recent years, mining activity has had a trend of shifting from developed nations to developing nations. Many of these developing countries do not have stable political and regulatory environments, which increases the risks for mining companies including Indian mining companies with overseas operations.

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Many new mine developments are in unstable political jurisdictions with ill-defined legal and regulatory systems and unstable royalty and tax regimes, which can be important sources of income to governments in need of revenue.

As developing nations are in need of revenue; however, do not have heavy industrialization or economic activity. Therefore, they increasingly rely on mining activities, which is a low-value-adding activity, to generate revenues by increasing financial charges.

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Margins may be eroded when regime changes increase royalties and taxes and impose expensive environmental regulations

In fact, the risk of adverse regulations or political change is so high for mining companies that at times, such changes happen at short notice and may even prevent mining operations or make them financially unviable.

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The imposition of trade barriers or changes in taxation or royalty regimes can happen overnight and significantly change the economics of a metals and mining company.

Many times, govts. Impose trade barriers to preserve the better quality of mineral ore (national resources) by imposing trade barriers or limits on ore extraction. This impacts the ability of the mining companies to operate at full/higher capacities.

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in certain commodities, like high grade iron ore, there exists a barrier to exports in the form of an export duty.

mine’s production ceiling approved in the mining plan/environmental clearance

Therefore, mining companies are in the tight grip of govts. and regulators, which control who can mine the minerals, how much it can mine and also extract a significant portion of mining income as royalties, taxes, cess etc.

Due to high regulatory interference, the mining industry in India is dominated (70% output) by public sector companies.

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domestic mining industry is dominated by large public sector undertakings (PSUs), who contribute around 70% to India’s mineral output by value.

Many cases of participation of the private sector were linked to crony capitalism and favouritism. As a result, in 2014, the Hon. Supreme Court of India cracked down on coal allocation practices and cancelled the allocation of a large number of coal blocks (Source: Supreme Court quashes allocation of 214 coal blocks).

Since the judgment of the Supreme Court, govt. has started following the auction process for allocating mining blocks to private parties, which has improved transparency in the system and has helped more private companies to enter the mining sector.

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In the new regime post the Supreme Court judgments, mineral resources to private entities can be granted exclusively through auctions.

With auctions for allotment of new mines to private players, mining leases have become accessible to new entrants. However, due to usually high auction premiums for such allotments, those mining players who still own mining assets under older regulations are at an advantage because their cost structure (levies by govt.) is lower leading to cost advantages.

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as fresh mining leases are being distributed through auctions, giving the existing players who have bagged mines under the erstwhile allotment regime a distinct competitive advantage

In addition, to accelerate growth, govt. is relaxing the mining regulations for promoting investment by the private sector in mining operations. Govt. has taken multiple such steps like relaxing the approval process, allowing captive mines to sell ore in the open market, and allowing 100% foreign direct investment (FDI) in the mining sector.

Rating methodology for mining entities by ICRA, June 2021, page 2

automatic transfer of statutory clearances of an expired mining lease which gets auctioned to the winning bidder, provision for upto 50% merchant sales by captive miners…provision for pre-embedded clearances for making auctions more attractive

Criteria for the mining industry by CRISIL, February 2021, page 16:

with 100% FDI being permitted, the competitive landscape is expected to evolve and monopoly of state players reduce

9) Environmental and social risks faced by mining companies:

Mining activities have a significant adverse impact on the environment and cause a lot of pollution. In addition, many times mines are located in remote areas with forest cover and mining companies have to cut trees for the development of mines to extract the minerals.

In addition, mining operations produce many by-products, which are harmful to the environment.

Criteria for the mining industry by CRISIL, February 2021, page 18:

Given the toxicity of many of the products and by-products in the mining process, mining concerns face the risk of their ongoing operations possibly violating environmental regulations.

One of the waste products produced by many mines is tailings (a finely ground rock), which contain many harmful materials. The tailings storage facility (TSF) near the mine is a health hazard for workers and the local population and companies have to spend resources to manage the same.

Global Methodology for Rating Companies in the Mining Industry by DBRS Morningstar, page 5:

Mining operations generate waste output in the form of finely ground rock (referred to as tailings)…Each mining operation should have a tailings storage facility (TSF) for…treatment necessary to mitigate any deleterious elements contained therein.

Many times, due to the harmful impacts of illegal mining, courts have come down heavily on the mining industry, which has also included a complete ban on mining activities in specific areas.

Rating methodology for mining entities by ICRA, October 2016, page 4:

Recent judicial interventions into illegal mining, specifically in areas like environmental and forest clearances, have led to mining disruptions in key mineral bearing states like Karnataka, Goa, and Odisha.

Due to the significant environmental impact of mining minerals like coal and iron ore etc., nowadays, govts are promoting the use of renewable energy as well as using scrap instead of ore to produce metal, which may impact the demand for fresh mining of minerals.

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For hydrocarbon minerals like coal and lignite, the GoI’s policy focus on renewable energy could temper their demand in the medium to long term. Moreover, evolving trends of higher resource recovery through scrap could reduce the intensity of virgin ore usage

Similarly, changes in packaging material with more use of plastic over aluminium/steel may impact the demand for mineral ores.

In addition to the environment, mining operations significantly impact the lives of the local population, which increases the social risk for mining companies. Many times, the development of a new mine or expansion of an existing mine leads to the displacement of many people. On other occasions, people encroach upon the land belonging to the mine, which adds to the complexities of mining operations.

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new mine development has challenges associated with land acquisition/ rehabilitation and resettlement…leading to project execution delays and cost over-runs. Moreover, illegal encroachment of lease area is a common problem facing many mining projects.

Many times, mining operations, globally, face protests by local populations, which necessitates proper diligence by the mining companies to continue operations.

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Mine development and operation also attract public attention and have a high social impact, often resulting in organized public opposition and requiring the agreement of local populations

Mining operations are labour-intensive and a significant number of employees are from the local population. Therefore, it becomes essential for the company to be very cautious in dealing with local issues to run its operations without interruptions.

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given the high labour intensity in mining operations, ICRA also analyses manpower productivity measurement parameters

Summary

Mining companies do not have any pricing power because they produce non-differentiable products and a customer can easily switch from one mining company to another to meet her ore requirements. In addition, mineral ores are easily transported by sea across countries; therefore, global demand and supply situations influence prices in every country. As a result, everywhere, mineral ores are traded on global parity prices taking away negotiating power from mining companies.

The mining business is highly capital intensive because it takes large investments and even more than 10 years to develop and start ore extraction from a mine. Even, subsequently, mining operations require continuous investments to improve extraction methods, upgrade machinery, and meet environmental norms. As with time, easy-to-access ore deposits get exhausted, and extracting more ore from deeper/underground levels requires more investments.

A large requirement of capital with long lead times for mine development act as entry barriers for new players. However, these factors also increase the cyclicity in the mining industry, which follows a strong linkage of demand for ores from customers dependent on general economic growth. During upcycle, mining companies announce the expansion, which takes a long time to get functional by when the cycle has turned. Therefore, the industry faces oversupply when demand is low and ore prices crash.

Due to a lack of pricing power, being a low-cost producer is highly advantageous for mining companies due to intense price-based competition in the industry. Companies try to increase operational efficiency by saving on transportation costs (railway siding), energy costs (captive/long-term PPAs), higher mechanisation, monetizing by-products and outsourcing partial/full mining operations. However, many aspects affecting operating costs like quality and depth of ore deposits etc. are not in miner’s hands.

Large-sized mines have an advantage due to economies of scale benefits and a higher bargaining power over suppliers, which keeps their operating costs low. They can get long-term supply orders from customers, which brings stability to performance. Large mines can face industry downturns better as they can rationalize production, are more diversified and can raise finances easily.

Diversification is essential for mining companies to mitigate the effects of cyclical volatility in performance. The performance of mining companies extracting many minerals is relatively stable than standalone mines with one mineral. Mining companies with mines and customers spread across different regions are better as they can avoid local disruptions due to political, regulatory, social, and natural reasons.

The performance of mines with integrated operations is relatively better and stable because they can capture the value of the entire chain and benefit from the diversified customer base of metal products. The large size of integrated mining companies also brings scale benefits.

The mining industry is one of the most regulated because it extracts national resources, involves large tracts of land parcels and significantly impacts local people and the environment. It is a significant source of revenue for govt. due to multiple levies like royalties, taxes, cess etc. Many times, mining operations witness local protests. Local population encroaches upon mining land. Instances of illegal mining are common and at times, courts and govt. put large penalties and even ban mining operations due to noncompliance to guidelines.

Therefore, an investor should always keep in mind these multiple aspects of mining companies to understand their business position.

• No pricing power due to non-differentiable commodity products leading to intense price-based competition
• Capital-intensive business with a lot of time and resources required for mine development
• Cyclicity with high fluctuations in the business performance
• Operating efficiency, being a low-cost producer is the biggest advantage
• Continuous addition of cost-effective mineable reserves is essential for companies. Otherwise, companies lose cost advantages
• A large scale is a competitive advantage
• Diversification in operations is a big competitive advantage
• Integrated mining companies have competitive advantages
• Very high regulations and associated political risk
• Large environmental and social risks

We believe that if an investor analyses any mining company by keeping the above factors in mind, then she would be able to assess its business properly.

Regards,

Dr Vijay Malik

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Disclaimer

Registration status with SEBI:

I am registered with SEBI as a research analyst.

Details of financial interest in the Subject Company:

I do not own stocks of the companies mentioned above in my portfolio at the date of writing this article.