Liquidity Problems of Mining Investments

On Aug. 22, 2008, Fitch Ratings published a special report entitled “Corporate
Liquidity: Bank Agreements and Refinancing Risk,” which discusses Fitch’s view of the
current credit market environment. The report emphasizes that Fitch’s ratings and
analysis of corporate liquidity are weighted more heavily on internal sources of funds:
cash holdings and cash generated from operations.
Since that time, the credit market tightened significantly raising the specter of a
consumer recession. Metal prices have fallen sharply and production and capital
expenditure cutbacks are being considered or announced. Demand from China and
other developing nations has driven strong growth in consumption and indications are
that growth will slow for at least the next 12 months. The HSBC North America Mining
Index, a capitalization weighted index, has halved since Aug. 22, 2008.
Steel, aluminum and copper prices are expected to trough in 2009. Coal prices and gold
prices are expected to hold up reasonably well over the next 12−18 months. Costs
should benefit from the decline in energy prices as well as production efficiencies.
While Fitch performs comprehensive ongoing liquidity surveillance as a function of our
core rating process, this report provides a more in-depth analysis of mining and metal
sector liquidity.
Key Conclusions
• Liquidity for the mining and metals sector is generally healthy. Most companies
have taken advantage of strong prices to improve their assets and capital structure.
• Free cash flow is highly influenced by capital spending programs, which can take
more than one year to complete. Curtailments in exploration and development to
conserve cash will result in short supply beginning in 2011 for copper, nickel and
zinc.
• Steam coal producers generally sell coal under long-term contracts where prices are
known for a period of three years. While volumes could be off from a very strong
2008, earnings should benefit from strong pricing momentum. Metallurgical coal
producers generally sell under annual contracts. Prices should benefit from fairly
tight markets over the next 12−18 months.
• Copper price swings are generally influenced by speculative demand and the recent
precipitous fall was accentuated by financial buyers unwinding positions.
• While some earnings are expected to decline in 2009 from robust 2008 levels, runoff
of working capital and active management of capital budgets should partially offset
the impact to free cash flow. Financial covenant levels should not constrain
borrowing under the revolving credit facilities over the next 12−18 months.
• On Sept. 30, 2008, Teck Cominco Ltd. signed definitive credit agreements totaling
$9.81 billion, which it plans to use for funding the cash portion of its takeover of
Fording Canadian Coal Trust. The agreements include a fully underwritten $4 billion
senior term loan and a $5.81 billion senior bridge loan.