Fitch Ratings: Global Miners Focus on Capex, M&A on Back Burner

(The following statement was released by the rating agency) Fitch Ratings-London-March 15: The world's largest mining companies are prioritising organic growth at the late stage of the commodities cycle, while M&A options are of lower significance to them, Fitch Ratings says. Our ratings of many companies in the sector, including BHP and Rio Tinto (LON:RIO), assume more conservative capital allocation than before the downturn of 2015. The chief executives of a number of large miners, including BHP and Anglo American (LON:AAL), highlighted at last month's BMO Global Metals and Mining Conference that organic growth is their main focus. While they may be open to M&A in principle, it is unlikely that acquisitions could match the internal rates of return in excess of 20% that are achievable through developing latent capacity at existing sites, or employing technology and innovation to increase production and optimise costs. These brownfield projects entail much lower spending and better payback visibility than M&A and greenfield projects. Implementing such projects, as well as rolling out best operational practices across portfolios, provides meaningful earnings upside for large, diversified miners without the higher execution risks of greenfield expansion or acquisitions. Our ratings of various miners factor in disciplined capital allocation; therefore, any large debt-funded M&A or several significant greenfield projects pursued in parallel could affect ratings. Similarly, any material growth in supply due to large greenfield projects that depresses commodity pricing could negatively affect the sector. This, coupled with high capex commitments of miners that implement the greenfield projects, could put pressure on miners' credit metrics. Companies' management confirmed that they are comfortable with their existing levels of net debt, and sustaining rather than reducing them in the long term is their priority. As metals prices recovered following the downturn in 2015-2016, large diversified miners divested a number of assets to focus on their most profitable, large-scale operations. This helped to strengthen their balance sheets, thanks to reduced debt and significant cash balances. However, in the past, many companies pursued M&A and greenfield projects towards or at the peak of price cycles at inflated prices. Therefore, we scrutinise whether the companies' changes in approach to debt and spending are sustainable and whether they could be maintained thorough the cycle. The emphasis on shareholders' returns has increased at this stage of the cycle, but we expect large miners' dividend policy to be linked to performance, and any additional returns to be discretionary. We expect rated miners as a group to generate positive - albeit declining - free cash flow in 2019 and 2020, despite an uptick in capex and dividends. As the cycle turns, we expect - particularly for investment-grade companies - a better alignment of spending with levels of their operating cash flows than during the previous downturn.