“As we headed into 2010, Capital allocation was the number one risk facing global mining and metals companies. A year on and a dynamic shift in the industry has occurred, largely thanks to the recovery of prices and record cash flow and earnings. However capital allocation still remains high up the risk agenda.”Lee Downham, Global Mining and Metals TAS leader, Ernst & Young
Summary: What a difference a year makes in capital allocation. In 2010 Capital Allocation was the number one risk for mining and metals companies as they experienced wild swings in prices, exchange rates, capital availability (debt & equity), minerals taxation regimes and risk appetites. This volatility made decision-making around how to allocate capital extremely difficult.
If capital was available, it was most likely equity and biased allocation decisions in favor of organic growth.
Despite the industry being in a strengthened position in 2011, the capital allocation challenge remains a big issue for many companies. External risks need to replace depleting reserves, and narrowing growth opportunities make the decision of how and when to allocate capital extremely complex.
Indeed, our 2010 “Governing not grinding” report (audit committee survey) highlighted the importance of ongoing assessment of risks, accepted rates of return and impact on capital allocation decisions. It revealed that numerous major projects were delayed or divested where the level of risk and rate of return appeared misaligned, and that hedging strategies were being re-considered by many.
It also confirmed that capital was being diverted into vertical integration to mitigate price risk; into value-add product ranges to minimize margin impact; and into geographical diversification to mitigate political risk. Some shareholders, who don’t perceive there has been an adequate return on investment for the risks being undertaken, are demanding surplus cash be returned to them.
|Steps mining and metals companies can take to respond to this risk: |
- Ongoing, regular risk assessment and evaluation of accepted rates of return
- Explicitly express risk appetite
- Scenario planning and testing
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