Scrambling out of Africa

Australian mining companies are finding Africa too hot, and heading for the exits.

Summary: Africa has been a favoured destination for Australian mining companies for decades, with its vast mineral resources proving irresistible. But now the rush is the other way, with the risk/reward ratio swinging against doing business on the continent. There is a combination of factors behind that swing.
Key take-out: For investors, now is good time to rethink any exposure to Africa. While the continent can deliver high profits, it can equally destroy capital at a faster rate than anywhere else.
Key beneficiaries: General investors. Category: Shares.

Out of Africa has taken on a new meaning for Australian mining companies, which are making a rapid exit from the continent as a decade-long rush peters out.

The speed of the retreat has been much quicker than the gradual build-up of interest in Africa as an investment destination for Australian capital.

Just how quickly the attractions of Africa are fading was on display this week at the annual Mining Indaba conference in South Africa’s port city of Cape Town – or to be more accurate, it was not on display because so few Australian mining companies attended.

The event, marketed as Africa’s biggest mining investment conference, was dominated by lawyers, engineers, accountants and equipment vendors hoping to sell their services to miners who have traditionally made a beeline for Cape Town every February.

This year, the miners simply did not turn up. While delegate numbers were the same as last year, with around 7,500 people paying to attend the three-way event, they found themselves largely talking to each other, or listening to politicians and government employees drone on about the attractions of their respective countries.

One of those politicians was Western Australian Premier, Colin Barnett, who delivered a keynote speech on Wednesday promoting the legal framework that has made his state a mining powerhouse and a prime location for mining investment.

Ironically, it seems that the miners most likely to take up Barnett’s invitation to do business in WA are the same Australians who left the state over the past 10 years to try and make a fortune in Africa.

Where the WA Premier might succeed with his marketing mission is in introducing Australian service providers to Africa, but as most of those are private companies or professional partnerships there is nothing in their success for outside investors.

Shifting sands

What can be learned from the absence of Australian miners at the Cape Town conference is that there has been a fundamental shift in the risk/reward ratio.

Whereas Africa’s undoubted geological appeal is with ore bodies that are, in many cases, much richer than anything in Australia, there are too many other pressures crushing interest in the estimated 200 small-to-medium Australian-based companies that have tried their luck in one or more of Africa’s 54 countries.

For me, a regular at Mining Indaba over the past 10 years, the no-show of Australian miners and the flood of service providers was a wake-up call that conditions at the small end of the resources sector have probably never been worse.

For investors, that must ring warning bells that it is time to rethink exposure in any form to a continent that can deliver high profits, but can equally destroy capital at a faster rate than anywhere else.
Graph for Scrambling out of Africa

The issues that are killing Australian interest in Africa’s mining sector include:

  • The general downturn in commodity prices, especially gold, which is the easiest metal to produce in Africa as it does not require extensive infrastructure such as railways and ports for it to be exported.
  • The collapse of investor sentiment towards small mining companies, many of which are struggling to survive with low cash balances, an inability to raise additional capital, and the certainty that they will not be able to raise debt from the banking sector.
  • The sharp fall in the value of Australian dollar, which is making overseas investments by Australian companies up to 20% more expensive given that most mining costs (and income) are measured in US dollars.
  • Sharply-worded warnings from major accounting firms that investment conditions in some African countries have worsened considerably over the past 12 months.
  • The traditional problems of poor infrastructure, which makes development of a bulk mineral project such as coal or iron ore, extremely difficult, especially given the inability to raise debt or equity capital to fund a railway or port development.
  • Greedy governments, which can change the terms of a royalty or profit-sharing agreement overnight, and a heightened risk of forfeiting a discovery if it is not developed in the time specified in a government agreement.
  • A poorly trained workforce, which might have the advantage of being cheap but that also generally means low skill levels, and
  • Competition from foreign companies, especially those from China, which have access to capital from their government-controlled banking sector.

African success stories

There are individual success stories which defy the downturn, but they are rare in the overall context of the 200-odd Australian companies which have been exploring in Africa.

  • Mineral Commodities (ASX code: MRL) has just completed construction of the Grande Cote titanium and zircon project in the West African country of Senegal.
  • Base Resources (BSE) expects to make its first shipment of titanium minerals from its Kwale project in Kenya later this month.
  • Tiger Resources (TGS) is posting handsome profits from its Kipoi copper project in the Democratic Republic of Congo.
  • Resolute (RSG) is successfully operating the technically complex Syama goldmine in Mali and Perseus (PRU) is operating the Edikan goldmine in Ghana.
  • Blackthorn Resources (BTR) is part owner of the recently-completed Perkoa zinc project in Burkina Faso.

Successful as each of those companies has been, the collapse in commodity prices and investor sentiment can be seen in their share prices. Perseus, for example, has fallen from $1.97 to 40 cents over the past 12 months. Resolute is down from $1.45 to 51 cents.

However, rather than look at individual success stories (or failures) it is the overall trend which points to a significant change of direction by Australia’s mining companies, who are finding Africa more expensive and less attractive than at any time in the past decade.

The challenge facing Australian miners in Africa was highlighted during the week by special reports from two accounting firms, Deloitte and Grant Thornton.

Deloitte, in a report coinciding with Premier Barnett’s visit to Africa, said WA-based mining companies were struggling “with a range of production, cost and productivity issues.”

WA companies in Deloitte’s index of state-based stocks fell in value by 44.5% over the past year.

The accounting firm’s markets partner in its Perth office, Tim Richards, said: “supply issues are impacting production economics in a number of countries, with the industry facing a rising cost curve and a declining productivity profile as a result.”

Grant Thornton was even more pointed, saying in its report that there appeared to be a significant lack of foreign investment capital to develop mining projects in Africa because “the continent still poses too many challenges to investors, and these obstacles are growing as African governments mature”.

Lauren Patlansky, managing director for Grant Thornton’s Asia Business Service, said there were massive opportunities for mining throughout Africa but delays in development approval were prohibitively costly, and while the challenges were not new “they are becoming more onerous”.  

Investing in Africa

For investors who retain an appetite for the potential high reward from rich African geology, and are prepared to carry the risk associated with the region, there are a set of rules to apply when filtering the attractive from the not so, including these two critically important factors:

  • Commodity. Choose very carefully. Gold has been an African natural for centuries but the collapse in the price over the past two years has left many small miners exposed with high-cost operations while bulk commodity hopefuls such as companies planning to mine iron ore in West Africa will struggle to raise the billions of dollars required for infrastructure. Uranium explorers are dogged by low prices.
  • Country. There are 54 to choose from with perhaps a dozen in the no-go category (such as Somalia and South Sudan). The bulk of countries are in the moderate government-risk category, and half-a-dozen are in the low-risk category (such as Botswana, Namibia and Zambia). South Africa, the home of Africa mining, is mainly seen as a centre for essential services and not for direct mining investment.

Because Australian miners are an adventurous lot, there is not much that will stop them from continuing to explore new frontiers, such as the more remote parts of Africa.

But that does not mean any of their discoveries are worth the risks associated with the country involved.

The changes underway in world commodity and financial markets (including the exchange rate) means that Australian is set to enjoy a revival of interest with the return of its missing miners.