Commodities

David Fickling is a Bloomberg Gadfly columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.

January is a great season for bargain hunting, and mining mergers should be no different.

That's particularly the case after the sector's lackluster performance last year: Across all sectors, M&A activity during the 12 months totaled a record $3.7 trillion, as Gadfly's Tara Lachapelle notes, but the $65 billion-odd in mining deals made 2015 the second-weakest year for that industry since 2005. The average premium paid -- 41 percent -- was more consistent with a booming market than one in the doldrums.

Not Hurting Enough
Premiums paid for mining takeovers suggest sellers still aren't feeling distressed
Source: Bloomberg
Note: Shows premiums and deal values for all mining company takeovers by year

Things may be about to change, if you're persuaded by the strategy being pushed by analysts at Bank of America. BHP Billiton and Rio Tinto should sell as much as $21 billion in new shares to strengthen their balance sheets and snare funds to pick up high-quality assets at discount prices, they wrote in a note to clients Wednesday. The only problem is, a glance at the mining assets that may be worth purchasing suggests shelves as bare as a Brezhnev-era supermarket.

Take all the world's mining companies, then exclude those that are trading above their book values, those that posted net losses last year, and those that analysts expect to report falling sales this year. That leaves just 30 out of 2,824 miners for which Bloomberg has data. You should also probably knock out Bumi Resources, the debt-laden Indonesian coal miner on which banking dynasty scion Nat Rothschild lost a reported 80 million pounds ($117 million), and G-Resources, a gold miner in the process of turning itself into a financial-services business. Anglo American Platinum and New Hope, both controlled by larger groups that have signaled an interest in holding onto their assets, can also be taken off the list:

Discount Sale
These 26 mining companies are all trading at a price-to-book ratio of less than 1
Source: Bloomberg

There's some potential among the remaining 26 corporates for those wanting to make bullish bets on unfashionable commodities. Twelve of the group mine gold, which is now down 43 percent from its September 2011 peak. That includes billion-dollar companies such as Newmont, Gold Fields, OceanaGold, and Acacia Mining. Clearly, there's risk in any business so heavily exposed to a single commodity, but five of that number are making profit margins of 10 percent or more, so stand a decent chance of surviving any further decline in the precious metal.

Panning for Gold
These five gold miners are all posting net income margins of 10% or more
Source: Bloomberg
Note: Shows all gold miners that posted net income margins of at least 10% in their most recent quarter, which are trading at a discount to their book value, and whose revenues will hold steady or increase in the current year, according to analyst estimates

The next biggest group is coal miners, represented by seven companies. Prospects for coal after last month's UN Conference on Climate Change don't look too hot, but for those not put off by sin stocks, finding the diamonds amidst the dross is often the essence of value investing. Nathan Tinkler, the former electrician who made and lost a fortune buying Australian coal assets during the commodities boom, is hunting for new pits, Bloomberg's James Paton reported.

Cloud Peak Energy, which mines exclusively in Wyoming's low-cost Powder River Basin, is trading at just 12 percent of its book value. SunCoke Energy and Shougang Fushan both focus on coking coal, the higher-quality variety used to make steel. Coking coal should be more resilient to controls on carbon emissions and the rise of renewable energy than the type used in power stations.

Diamonds, copper, zinc, platinum and mineral sands make up the remainder of the list. The largest of that group, Canada's Dominion Diamond, said last month it was taking advice from Rothschild on ways "to maximize shareholder value" after reports it is exploring a sale. Copper-gold miners Rambler Metals and Hillgrove Resources are exposed to a commodity that Morgan Stanley analysts expect to be one of the three best performers this year, and can be picked up for less than 10 percent of their asset value.

Cheap at the Price?
Operating margins at key divisions of major miners, trailing 12-month
Source: Bloomberg

The Bank of America analysts suggest one rather more Machiavellian strategy that BHP and Rio could pursue. By getting their equity raisings away early, they could sate the market's appetite for new mining shares and starve more-indebted competitors like Anglo American, Teck Resources and Fortescue Metals. That will increase the odds that those miners' better assets will eventually come to market at fire-sale prices, ready to be snapped up by the companies that raised capital first.

Anglo American made clear last month that it will hold onto its diamonds, platinum and copper assets at all cost. Set those aside, and all that's left is Anglo's coal and iron ore, Fortescue's iron ore, and Teck's mix of coal, copper, and zinc.

It's not clear why either Rio or BHP would be keen to buy lower-quality iron mines during a price crash for the metal, let alone whether regulators would allow such consolidation by the second- and third-biggest players. Competition rules would also probably prevent BHP acquiring more coking-coal assets, although there may be an opening for Rio Tinto if it could avoid the thermal coal that it so clearly doesn't want to own. Both have historically shown a marked disinterest in zinc, although Teck's copper assets might be attractive to either. 

If this is the straightest path to getting a deal done in the mining sector, it's little wonder things are so quiet.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
David Fickling in Sydney at dfickling@bloomberg.net

To contact the editor responsible for this story:
Katrina Nicholas at knicholas2@bloomberg.net