Analysis of capital allocation by mining companies

Abstract

Correct timing of capital allocation in relation to commodity price is one of the key drivers of long term success for capital intensive companies such as mining companies. Nonetheless, historically mining companies have in general been poor at capital allocation decision making. This is mainly because they allocate most of their capital during the top half of a commodity price cycle which has often proved to be the incorrect time of the commodity pricing cycle to invest in growth projects. This in turn has led to poor returns on capital invested, impairments, underperformance in the share price of mining companies relative to other industries and ultimately destruction of value. Better capital allocation strategies are required for mining companies to unlock more value from invested capital. This paper identifies factors in the capital allocation decision-making process that can unlock value in mineral projects. Five international mining companies were analysed from 2001 to 2017, a period that covers a full commodity price cycle to determine the correlation between commodity price and capital allocation by mining companies. It was found that during periods of higher commodity prices, the analysed mining companies primarily focussed on volume growth. In a declining commodity price environment they focussed on rationalisation of mining projects and operations, and disposal of assets that do not meet minimum investment criteria. Mining companies should consistently invest capital throughout the commodity price cycle, and be cautious of over allocating capital towards growth projects during periods of high commodity prices.