SMART DOG MINING^TM
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In the past, if anyone had asked for a one word describing the mining industry, that word would probably have been “stable”, yes it had its swings but generally it was fairly stable.  Not glamourous, but necessary and stable.  Not today, a better word would be “dynamic”.   That’s dynamic in its changing or unpredictable meaning.

One area that this has hit the hardest is in the financial side, attracting and keeping the capital needed to run or build a mine.  Mining companies are facing significant capital demands at a time when capital is hard to come by.   Revenue is flat or even decreasing, prices are down and still falling, and cash flows are weak, which means borrowing stresses the balance sheet and challenges credit ratings.  Issuing equity dilutes shares, and can cause future problems in financing.

While this has hit the juniors hard, the majors are also feeling the pinch, with projects being delayed or cancelled.  Ernest & Young has rated this one of the top dilemmas facing the mining and metals Industry (Business Risks Facing Mining and Metals 2013-2014 ranked it first & Business Risks Facing Mining and Metals 2014-2015 ranked it second).  On mining news sources (Mining.com, Mineweb, and similar) this topic is one of the main stories for the last several years. 

Combine this with mandatory spending for regulatory and safety issues, expansion and growth money must be managed carefully. The good old days of high metal prices and easy capital for funding projects and even daily expenses appears to be gone.

To have a hope of meeting their capital needs, miners need to get as much value as possible from every capital dollar invested. Examining the value of each capital dollar carries short- and long-term benefits.

In the short term, it can result in the release of tens of millions of dollars of trapped capital, allowing utilities to fund projects that would otherwise be forced to wait. In the long term, companies can be confident that they’re investing capital in the right way and getting the most for every capital dollar.

While the variability of the ore has always been with us, variability in costs and revenues is now with us.  This means going from a static budget to a dynamic budget and using dynamic planning as a tool.

Tools for Dynamic Forecasting and Budgeting are becoming available (http:/www.alightinc.com).  These tools provide a budgeting and planning solution that enables the management team to communicate to top management and shareholders the key business drivers that most impact your company's bottom line.

Budgeting is simple, but that does not mean it is easy!

In another post I discussed the concept of Dynamic Budgeting (Dynamic Budgeting in Mining (https://www.linkedin.com/pulse/dynamic-budgeting-mining-mike-albrecht-p-e-)) as a way to allocate capital.  But, to paraphrase von Clauzewtiz, budgeting is simple, but in budgeting the simplest things become very difficult!

In the mining industry it can become very difficult, but some companies do manage, even in a down market, to do well.  Ralph Aldous ( portfolio manager with U.S. Global Investors), in an article in The Gold Report (3/25/15) (1) commented that those companies that do it well follow used the five principles of capital allocation as defined Michael Mauboussin (2).

The five principles of capital allocation include:

·       zero-based capital allocation;

·       fund strategies, not projects;

·       no capital rationing;

·       zero tolerance for bad growth;

·       know the value of assets and be prepared to take action.

While directly applicable to companies in production, they also can be applied to exploration and development phase companies.

Zero-Based Capital Allocation

Many companies budget on an incremental (inertia) basis, if x was allocated last year will allocate x next year.  Have each division justify their needs for the next budget cycle.  Companies and divisions need a strategy to determine the proper amount of capital spending.  And in a dynamic environment this can change year by year (even more quickly sometimes).

Fund Strategies, Not Projects

It is a common mistake for companies to push a project forward—particularly if it is its only project—even though it lacks the potential for great returns.  Determine the corporate strategy and then fund what meets that strategic goal. In a dynamic environment, a project that looks good today can be bad tomorrow, consider alternative scenarios before committing.

No Capital Rationing

Typically, miners believe that capital is scarce but free. They believe that capital comes from profits and is thus “free” money but since it is internal it is “scarce”.  Properly speaking, capital is plentiful but expensive. Profits need to be spent in a manner that results in future profitability. And equity financing is only plentiful if you have a good project. The limiting resource for many companies is not access to capital but rather access to talent that has the skill set to properly allocate the capital and make the hard decisions..

Zero Tolerance for Bad Growth

Don't throw good money after bad. Not every investment will pay off.  Having a project fail is not a sin, but keeping a project going long after it has proven of little value is. Mining companies should always seek to upgrade their portfolios.  In a dynamic environment this can be crucial to survival, hanging on to a project “just because, maybe” can drain resources needed elsewhere.

Know the Value of Assets and Be Ready to Take Action to Create Value

Many in the mining industry don't know the value of their assets. Companies quote their value based on their resource statements and then decide to budget on this basis.  In a dynamic environment valuing a company based on what it would be worth on the market makes more sense.

To sum up, the proper budgeting, especially under dynamic conditions, is to maximize long-term value per share. 

(1)   Ralph Aldous interview in The Gold Report (3/25/15)

(2)  Capital Allocation: Evidence, Analytical Methods, and Assessment Guidance published by Credit Suisse