Junior miners on verge of extinction

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Australia’s major mining companies may be relatively safe, given their scale and diversity, but we could see many of our junior miners and explorers go to the wall in the near future.

Falling commodity prices have made several projects and operating mines uneconomic, and investors are increasingly seeking low-risk, high-yield investments, pushing smaller miners and explorers out of the investing universe. On the other side, rapidly rising production costs also have a negative effect on earnings and it’s not hard to see why investors have been deserting the sector en masse.

Unable to raise cash, smaller resource companies are struggling. According to a new report by Ernst & Young, around 20% of junior listed mining companies have less than US$1 million in cash and equivalents on their balance sheets as at December 31, 2012. With the position investors are taking, junior miners are being starved of capital.

As a result, we could see a round of consolidation in the resources sector. Those companies that have the cash will have the flexibility and opportunity of picking up mining assets at much cheaper prices, while those with uneconomic prospects will either exit the market, or be forced to put their projects on hold for the near term.  Some will be hoping for white knights to come in and rescue them.

The major miners haven’t had it all their own way either. The Ernst & Young report notes that around US$30 billion of asset impairments were recorded in the December 2012 reporting season by the six largest miners alone. We’ve also seen Newcrest Mining (NCM.AX) write off up to $6 billion from its purchase of Lihir Gold in 2010, and just last week, Kingsgate Consolidated (KCN.AX) wrote off $300 million 0n its purchase of the Challenger gold mine.

Investors punished those companies and we’ve seen a changing of the guard, with new CEOs at BHP Billiton (BHP.AX), Rio Tinto (RIO.AX) , Anglo American, Newmont Mining and Barrick Gold. The new CEOs have been given the task of focusing on controlling costs and improving short-term cash flows.

Foolish takeaway

Investors are now demanding a structural shift in the way resources companies operate. For too long resources companies have failed to generate adequate returns to shareholders. Much of the incoming cash flow was reinvested into new projects – some of which were not successful, while shareholders received no dividends along the way, and watched as the share prices plummeted.

As a result, investors are no longer willing to invest in junior miners or explorers in the ‘hope’ of seeing a return someday down the track.

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Motley Fool writer/analyst Mike King owns shares in BHP and Kingsgate.

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