Mining industry still offers solid investment opportunities

As investment counsellors, we have been arguing successfully that segments of the mining industry offer attractive investment opportunities. The argument can be divided into two phases. The first is the traditional supply-demand analysis for the industry. The second is an analysis of the restructuring steps that individual companies have undertaken and what that can mean for the industry and for future levels of profitability. The argument is not an easy one because there is probably no sector of the equity market so subject to prejudice as mining. Our current recommendations of mining companies emphasize copper. A look at the 20-year history of worldwide copper consumption illustrates some interesting points to those who believe that the U.S. determines the outlook for this metal.

First, the U.S. copper market is smaller than that of Europe and by itself accounts for only 25% of the West’s metal consumption. Furthermore, U.S. demand has been more volatile than consumption in Europe and Japan.

Our view is that economic conditions abroad are likely to remain favorable. Recent forecasts indicate that growth in Germany may be higher than observers had anticipated. In fact, the world’s softest industrial market may prove to be the U.S. Last year, world copper consumption was about 8.3 million tons. We think supply trailed that by 100,000 to 200,000 tons.

There are important new projects coming on stream: the expansion of the solvent extraction/electrowinning capacity at North American properties, for example, Asarco’s (NYSE) longterm move toward becoming an integrated producer. In addition, there are new projects in New Guinea and Chile that will add to capacity.

We could experience a difficult environment in 1991 and 1992. Prior to that we expect tightness. However, with the production interruptions we are experiencing now, supplies appear more likely to be short rather than ample. The outlook for aluminum and some of the smaller base metals also look good. Investors are interested in the specific steps that companies have undertaken to enhance the profit- generating power of present assets. For instance, we refer to the cost reduction program that Phelps Dodge (NYSE) so successfully implemented. Asarco is beginning to generate interest for its strategy of becoming an integrated miner, and Cyprus gets high marks for converting previously uninteresting assets into productive units.

Our investor clients are conceding slowly that the mining industry is not merely a list of companies whose outlook is dependent completely on exogenous factors over which they have no control (e.g. metal prices). Different strategies that companies have undertaken improve their competitive position, and some of these changes will result in higher levels of profitability at the next cyclical trough as well as the current peak. There are other actions that can help to overcome the reluctance on the part of investors to accept this change in the industry and specific companies. At the top of the list are the shareholders’ enhancement moves that have been made.

The combination of share buyback and dividend distribution that Alcoa (NYSE) and Phelps Dodge have announced have had no small impact on stock performance. I think the Alcoa formula approach (the company pays a regular quarterly dividend, then will pay out to shareholders 30% of everything earned above a set amount per share) can be exploited by others to a greater degree than it has thus far. Many investors don’t want to take the risk that comes with the cyclicality of metal stocks. My challenge is to convince them that the investment story is so compelling that the opportunity they are missing offsets the risk.

Even now, mining companies in the U.S. are trading below the valuations on a price earning basis of competitors in Europe, the Far East and even Canada. But there are some steps that can be taken to move toward higher valuations. Investor relations programs are far more active today than three years ago, and the material generated by them is far superior to past programs. Companies seem very willing to discuss the specifics about their restructuring programs. Investors have a better understanding about the improvements that have occurred at particular companies than at any point in the recent past. Mining companies can help make their stocks more attractive to the wary investor:

/d3h/ Make extensive use of your management team. Nothing can give credibility to a corporate policy to expand operations, enhance cash flow and improve the shareholders’ lot as much as hearing it from the people who are going to implement the program. I would argue that charisma is nice, but quiet competence raises confidence. Use investment meetings to show off your team.

/d3h/ Use investor meetings to discuss the current business environment. We cannot run away from the emphasis on quarterly earnings. Try to include some anecdotal evidence of incoming orders, prices and cost changes. Discuss which markets are strong, which are weak. Mining has a reputation for generating surprises. Disappointments cannot be hidden, but if investors believe that they will be kept informed, they will be better able to assess the impact of the declines when they come. Some may even be willing to ride through the down cycle.

/d3h/ Offer an evaluation of the industry environment. We think much greater discipline is being used by mining managements in determining whether to add to capacity. We think inventory policies among metals users are quite different today than five years ago. We conclude that the commodity prices are less vulnerable to the pressures of excess stocks overhanging the market than in the past. Corporate observations about these developments will be very helpful in giving investors reasons for being positive.

/d3h/ Be willing to discuss what is occurring in the markets. Are new competitive materials a threat? Are there new markets?

/d3h/ It helps to have an authoritative review of supply.

Investors regard management as the best and most accurate source of information about developments in the mining industry. How companies use the investor relations process can determine the views the investor has of mining.

I think mining’s story today is more exciting than ever. The audience is wiser. Together we can improve understanding about where we are and where we might be going and increase the market’s opinion about the value of mining assets in the process.006

Peter Anker is managing director of First Boston Corp. These excerpts of a speech he delivered during the latter part of 1989 recently appeared in the American Mining Congress’s newsletter “Washington Concentrates.”