If you think commodity producers are out of the woods as markets rally, here’s a reality check: many are still grappling to contain debt.
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Another year of belt-tightening hasn’t kept pace with an earnings slump after prices collapsed. One gauge of leverage among mining, energy and agriculture companies continued to increase within the fourth quarter and is a lot more than double year-earlier levels.
While recycleables have rebounded previously month, they’re still well below amounts of even two years ago – 28 per cent when it comes to copper and 64 per cent for crude. To finish the gluts that sank prices, companies needs to be cutting more output, however, many are still so deeply indebted that they must keep producing cash to stay above water.
“I call it the commodity conundrum,” said Jessica Fung, a commodities analyst with BMO Nesbitt Burns Inc. in Toronto. “Cutting production is completely the last resort for just about any company because you’re basically shutting down your revenue generation. And then what?”
More Defaults
Unless commodity prices extend gains, the conundrum holds grim consequences for 2016 for many producers. Your debt burden keeps growing for a lot of miners and drillers regardless of how hard they pump and dig. Corporate defaults will reach a six-year high this season, led by commodity companies, based on Moody’s Investors Service, which in January put 55 mining companies and 120 gas and oil drillers on watch out for possible downgrade.
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With crude crashing from a lot more than US$100 a barrel in mid-2014 to as low as US$26 recently, the debt ratios are becoming worse for many drillers, the investment-grade the likes of Anadarko Petroleum Corp. which have been cutting output and charges.
A surprise rally in metals since the start of the year has helped ease the responsibility for some gold producers, including Newmont Mining Corp. and Barrick Gold Corp., and mining stocks in February had their biggest one-month tear since 2009. Iron ore prices which had plunged for three straight years are up 46 per cent this season, though they’re still half what they were 2 yrs ago.
Burden Grows
But on a single key metric – leverage – most commodity producers are struggling.
“There’s still some decent income,” Egizio Bianchini, co-head of worldwide metals and mining group in the Bank of Montreal, said Tuesday in Toronto in the annual conference of the Prospectors & Developers Association of Canada, the world’s largest mining convention. “The issue is debt.” Bianchini estimates $50 billion to $60 billion in capital is needed for that mining industry to stabilize itself after the commodity rout.
Freeport-McMoRan Inc., the largest publicly owned copper producer, has seen its ratio of debt to adjusted earnings before interest, taxes, depreciation and amortization a lot more than be used as of Dec. 31, to 5.6 from 2.1 a year earlier, data published by Bloomberg show. The company on Jan. 26 said hello is looking to cut its $20 billion debt by $5 billion to $10 billion through multiple transactions.
Debt for oil and gas producer Anadarko was at 3.5 times adjusted EBITDA after 2015, compared with 0.9 last year, the information show.
“That’s a serious problem,” Bianchini said. “I had been taught in early stages your debt kills. It’s likely to kill a few companies this time around, or at best take a few appendages.”
John Thornton, Barrick’s non-executive chairman, said there are just three ways for extraction companies to pull from the spiral: produce more cash, issue more equity or sell assets.
Restructuring Industry
“Probably if prices stay because they are then we’ll see the coming year lots of restructuring of the mining industry,” said Diego Hernandez, chief executive officer of Antofagasta Plc, the mine owner controlled by Chile’s richest family. His company’s cash and liquid assets exceed debt, and Hernandez said hello may look to buy more assets in the right price.
For now, miners selling assets are charging too much simply because they haven’t accepted the matter that prices might be lower for a long time, said Oscar Landerretche, non-executive chairman of Codelco, the world’s largest copper producer.
Oil Producers
The oil industry is faring even worse.
Since the beginning of 2015, 48 North American gas and oil producers have declared bankruptcy using more than $17 billion in debt, based on law practice Haynes and Boone. Last month, Chaparral Energy Inc. and SandRidge Energy Inc. missed interest payments on their own debt. Both companies have drawn down their full credit line and hired legal and financial advisers, a move viewed as a prelude to bankruptcy.
Drillers’ debt ballooned to $237 billion after the 3rd quarter, a 12 percent increase in the previous year, according to the most recent data available that is published by Bloomberg on 61 drillers within the Bloomberg Intelligence index of United states independent oil and gas producers.
Interest Expenses
Keeping track of debt has gotten tougher, too. In the third quarter of 2015, interest expense exceeded 10 per cent of revenue for 28 from the drillers in the index. A year earlier, only 13 companies had debt payments that top.
Yet many producers had continued to enhance output until late last year. Part of the reason is that cash-strapped companies need to carry on growing to have their credit line from shrinking. The amount banks are willing to give loan to borrowers with riskier credit is dependant on how big a company’s reserves and also the cost of crude. The loans are usually readjusted twice yearly, around April and October. If your company doesn’t add new wells, then it’s reserves fall as the oil is pumped out of the ground and sold, causing its credit line to contract just once the company needs money most.
Miners don’t seem to be as near towards the bankruptcy cliff, partly because many negotiated longer-term debt following the last commodities downturn in 2008. The cost of shuttering a mine is enormous, meaning that creditors may be tempted to let companies still produce at a loss while still trying to shed their weakest assets.
And nobody knows how long the downturn is going to last.
“I’ve covered this industry because the late ’70s and that i would have to say I haven’t seen a scenario like this, of this magnitude,” said Carol Cowan, a Moody’s senior analyst. “We’ve concluded that this is not an ordinary cyclical downturn.”
Bloomberg.com
