african mining bulldozers

04 Sep 2020

Mining sector in need of a lifeline - liquidity critical

Lourens Campher

Lourens Campher

Head of Asset finance, Investec For Business

Covid-19 has magnified challenges that the mining sector was already facing before the pandemic. We explore available options to ease working capital.

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Q: What impact has Covid had on the mining sector and what trends are we currently seeing?

 

A: Before the global Covid-19 pandemic, the local mining sector was already grappling with various challenges. Weak global demand triggered a commodities slump, while low local economic growth, policy and regulatory uncertainty, and labour disruptions impacted domestic operations.

 

The pandemic's economic impact has magnified these challenges as it affected exports due to ports closures and government-mandated restrictions on mining operations. Domestic demand for resources also fell as Eskom reduced the amount of coal it was taking from its suppliers. These factors created havoc with mining companies' and sub-contractors’ cashflows. 

 

While the market has experienced a slow return to normalisation since July, no one is at full production yet. In fact, a number of mines opened and then, due to positive Covid-19 cases found amongst their workers, had to close again - further hampering trying to get back to ‘normal’. Additionally, new safety measures had to be put in place on the mines which also led to less productivity time and in some cases, three shifts a day have had to be brought down to two which had ripple effects through the cycle. As such, South African mines continue to cut costs to ensure their sustainability. Amid these cost containment measures; mine operators have to balance sustainability with the cost of production.

 

Miners must sustain investments into exploration and growth initiatives to ensure future sustainability, as well as projects that boost current operational efficiency and streamline production capabilities, while maintaining cash on hand to exploit potential market opportunities. But in the face of significant capital constraints and downward pressure on revenues, these investments can add to the sector's financial challenges and further impacts already strained cash flow. 

 

A lack of liquidity in the sector can spark a chain reaction in the working capital cycle, which takes a long time to normalise as every participant of the cycle gets affected by its own challenges and cashflows. For example, if a company’s debtors don't settle their debts, the company has to rely on its available facilities to pay its suppliers. If these facilities have been exhausted, it can create issues down the value chain as unpaid suppliers can't settle with their suppliers. Therefore, maintaining liquidity is crucial, now more than ever.

 

Q: Working capital is important in ramping up productivity and ensuring business continuity, what should the sector be looking at?

 

A: It’s critical to understand that the working capital cycle takes a long time to normalise as every participant of the cycle gets affected by its own challenges and cashflows at different times and stages. If we consider a scenario where a company’s debtors are not settling its debts, the company has to rely on its facilities available to make payment to its suppliers.

 

If these facilities have been exhausted, then there will be a delay in settling suppliers which will immediately put strain on them in terms of making settlements to their suppliers. This has a domino effect and takes an extended time to unravel. As such, utilising the support the financiers are providing such as repayment moratoriums on interest and capital as well as Covid-19 loan funding at prime with repayments over 5.5 to 6 years could be viable options for many businesses in this sector, given the industry projection and recovery curve.

 

Asset financing via leasing and rental finance also offer viable options to attract funding and unlock working capital, especially in circumstances where miners do not have access to bank funding or experience delays in client settlements. Asset financing can also unlock value by freeing up working capital for investment into other critical areas of the business, while boosting cash flow and liquidity to help sustain the business through situations such as the current economic crisis.

 

Additionally, for companies with longer term contracts, buying the asset under asset finance gives them more of a fixed cost versus renting an asset, which is more expensive and provides no control over future costs. Based on these benefits, we are seeing asset financing as a rising trend across capital-intensive industries and has gained significant traction in the mining sector over the last two years, particularly as it presents a viable alternative to renting machinery to complete projects, which is an expensive exercise, especially given market and project volatility.

 

Q: Should businesses be looking to sell and lease back their existing productive assets to obtain funding?

 

A: Making use of sale and leasebacks is a great way to attract funding. The funding can support the company’s cashflow cycle especially where its clients don’t have access to bank funding or experiences delays in its client’s settlements. With that in mind, if you are planning to replace the assets over the next 12 to 24 months through trade inns or outright sales, we suggest you refrain from sale and lease backs as you may incur deal costs or early settlement penalties if you want to early mature these contracts.  

 

Another important consideration is the tax impact on sales and leasebacks. The business may end up with recoupments and an unexpected tax liability that was not planned for.  

 

Q: Fixed interest rates and payment holidays – what options are available to ease working capital?

 

A: Partnering with the appropriate asset finance partner can unlock additional benefits. For instance, some financiers manage the administrative and logistical complexities of importing assets or offer the option to upgrade equipment during the leasing period and some are offering payment holidays and fixed interest rates on productive assets. Additionally, some also look at reduced payments during known slower periods, for example December and January.

 

When determining the optimal funding structure, financiers will assess various aspects of the business and the assets themselves. These elements may include the asset’s brand reputation and its sustainability, along with the asset's serviceability, commonality, broad-based usage and its productive life. 

 

Ultimately however, in the right circumstances, appropriately structured asset financing can help miners minimise their risks and maximise their cashflow at a time when the need for both has never been greater.

This article originally appeared in African Mining Brief.

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