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Mining sector business model

Mining companies' business model is based on the exploration, extraction, processing and sale of minerals and metals. The business model can be broken down into four stages:

  • Exploration and development: mining companies begin with exploration to identify mineral and metal deposits. This phase includes geological research, feasibility studies and obtaining mining rights.
  • Extraction: once a deposit has been discovered and deemed economically viable, the company moves on to extraction. This phase may involve open-pit or underground mining.
  • Processing : the extracted ore is then treated to separate the precious metals or useful minerals. Processing may include crushing, concentration by flotation, leaching or other metallurgical methods.
  • Sales and distribution : processed metals and minerals are sold on world markets. Mining companies may sell directly to manufacturers or through intermediaries.

The mining sector is very difficult to value. The mineral reserves and resources of a mine do not appear as assets on the balance sheet - only the cost of acquiring the mine. Indeed, data relating to mines is contained in ancillary documents produced in accordance with recognized international standards. These data do help to calculate the intrinsic profitability of the mine.

Cash cost, a key concept

To better understand the price dynamics of industrial metals - I specify industrial because some metals have specific mechanics that place them in other categories, such as precious metals (gold, platinum, silver, palladium) - it is important to understand the notion of a mine's cash cost. Cash cost represents the total operating cost of a metal or ore production unit, usually expressed in tonnes.

Cash cost is very important for miners and analysts as it serves as a barometer of a mine's profitability. If a mine's production cost exceeds the price of the ore it extracts, it must be closed. As a result, industry giants such as CATL for lithium and BHP for nickel have closed mines that are no longer profitable. The result is a drop in production and therefore supply, which will eventually rebalance market prices when demand picks up again.

If you start to analyzing a mining company, you'll often see the notion of cash cost followed by the term "FOB" (Free On Board), which is an international trade incoterm. This simply means that all costs associated with transporting the goods to the port and loading them onto the ship are borne by the seller. Once the goods have crossed the ship's rail, the costs pass to the buyer.

Example of a lithium mine's positioning on the cash cost curve. Source: Eramet H1 results

Numerous markets rather than a unique market

Heavy dependence on metal prices has prompted players to diversify. Most of the world's largest mining companies extract different metals from different mines scattered around the globe. As a result, there are as many markets as there are varieties of metal.

Indeed, our sector is part of a larger market: commodities. In addition to tangible goods involving issues such as transport and storage, commodities are characterized by price volatility, resulting from exogenous factors such as weather conditions, geopolitical tensions and fluctuations in supply and demand.

There are numerous trading points for metals. Among the most famous, we have the London Metal Exchange, the world's leading exchange for non-ferrous industrial metals (aluminum, copper, nickel, zinc, lead and tin); the New York Mercantile Exchange (NYMEX), now part of the CME Group, is another major venue for trading metals, particularly precious metals such as copper, lead and tin. Finally, in China, whose industry consumes more metals than any other in the world, the Shanghai Futures Exchange (SHFE) is one of the most important commodities exchanges in Asia.

However, not all metals are listed on the exchanges. Some of the rarer or less commercially voluminous metals, such as lithium, cobalt or rare earths, are often traded directly between buyers and sellers at points of sale (mostly industrial ports). The market for these metals is less transparent and can be subject to greater volatility due to the lack of standardization and liquidity compared to listed metals. The case of manganese, a metal indispensable to steelmaking, is relevant. Its price is determined by contracts concluded in various ports, depending on its origin. Mainly traded in Chinese ports, we can observe variations in prices for the same period, or even the existence of a time lapse before these prices are recorded.

Economic cycles and growth

As you can see, we're dealing with a pro-cyclical sector that is highly capital-intensive throughout its production chain. CAPEX investments quickly reach substantial sums, for a return that is sometimes limited or even uncertain. It is crucial to keep debt under control and rationalize the asset portfolio. Inertia between segments is a challenge for mining companies, to avoid finding themselves weighed down by an uncompetitive or loss-making branch.

When we look at the indebtedness of mining companies, it may seem rather low. The total debt/EBITDA ratio rarely exceeds 1 for biggest market caps. In reality, the sector's growth relies heavily on the creation of value chains. During upturns, sectors tend to concentrate, favoring M&A deals. This growth strategy is less risky and more profitable than developing new projects. Conversely, in times of economic downturn, companies tend to carry out joint ventures, suspend current projects or sell off assets. In this context, the focus is on operational control and maximizing shareholder returns.

Number of mining sector deals since 2004. Source : Bloomberg

The growth of companies in this sector is also driven by technological breakthroughs. Electrification, energy storage and recycling are emerging as growth vectors for the sector. The star of the moment is lithium, used in the latest-generation batteries for EVs. This metal, like nickel, is almost entirely recyclable, enabling companies to position themselves downstream of the value chain. Mining companies can be part of a sustainable economy, a notion once considered incompatible with the practice. Increasingly, these companies are putting forward environmentally-friendly practices, in addition to their legal obligations to rehabilitate sites they no longer mine.

The energy transition paradox

Extraction and refining companies face a new dilemma. As developed countries rapidly modernize, and industries such as solar photovoltaics (PV), EVs and batteries gain ground, there is a growing need for metals and minerals worldwide. Paradoxical as it may seem, mining is arguably the most important sector for the energy transition but also the least environmentally friendly. Direct environmental impacts include high energy consumption, GHG, soil erosion, sinkhole formation, loss of biodiversity and contamination of soil, groundwater and surface water.

The Role of Critical Minerals in Clean Energy Transitions, International Energy Agency, March 2022

ESG continues to top the list of risks and opportunities in the mining industry, which means that understanding and effectively navigating the myriad of ESG frameworks is crucial.

Going green comes with high upfront costs and, in some cases, new, less polluting technologies will need to be developed to reduce carbon emissions. But there is an upside: socially responsible investors and funds are looking to invest in low-emission companies, which increases their valuation. Customers are also willing to pay more. Numerous regulations push mining companies to improve their extractive activities.

Mining geography

The mining sector is a constantly evolving landscape. Against this dynamic backdrop, the world's leading mining operations dominate global production thanks to their rich soils. However, the emergence of new mining clusters bears witness to the sector's constant adaptation to technological change, market demands and environmental imperatives.

Source : Bloomberg

The main clusters

  • Australia is the world's leading mining country. Policies are favorable to mining. The country is a real standard-setter with its JORC Code (Australian Mining Code) widely used throughout the reference world. Stable government, transparency, technological expertise and crucial proximity to Asian export markets underpin the country's global leadership. Within the S&P/ASX 300 index, 19.6% are mining companies. This is one of the highest weightings for a national index.
  • China is the undisputed leader in global production of rare earth elements, with a market share of over 60%. Although the country is more dominant in terms of consumption of metals for transformation into industrial products, it also boasts a large number of mining giants. These are mostly vertically integrated state-owned entities, ensuring greater control over vital sectors of the economy. This enables the state to steer industrial development in line with long-term national objectives, although the viability of this model is being called into question. The indebtedness of Chinese mining companies is often higher than the sector average.
  • Canada and Brazil are two major mining hubs. The former boasts rich reserves of more than sixty minerals and metals, as well as superior mining infrastructures and a vast rail network to support exports. The latter also ranks among the world's leading producers of gold, tin, lithium, nickel and other minerals. However, the sector's growth is hampered by environmental requirements, in particular massive deforestation, which makes open-pit mining possible.

Regions in decline

  • The United States, despite its diverse mineral reserves, faces complex regulations, rising costs and public opposition. Moreover, the country imports the majority of key metals for EVs and electronics for the technology and defense sectors.
  • Russia is also a historical hub. However, governance problems, infrastructure shortcomings and high cash costs are holding back growth. In addition, Western sanctions imposed on major Russian mining companies since 2022 have severely hampered investment and access to new mining technologies.
  • The Democratic Republic of Congo, which, despite its rich soils, faces enormous problems in enabling responsible mining investment, including widespread government corruption, lack of transparency, armed rebel conflicts financed by mining control. South Africa, to a lesser extent, also faces social, environmental and regulatory problems.

The emergence of new players

  • While Chile is well known for its copper mines, it is now the focus of attention for a completely different metal. What has been described as the "white gold rush" has brought to light what geologists call the "lithium triangle". This region, straddling Chile, Bolivia and Argentina, is believed to contain 65% of the world's lithium resources. As a result, foreign mining companies are rushing to the region to take advantage of the metal's growth prospects, a guarantee of the energy transition.
  • Indonesia has established itself as a major player in the nickel field, establishing itself as by far the world's leading exporter. Indonesia's nickel boom has been driven primarily by China's growing demand for NPI (Nickel Pig Iron) ores, a fundamental component of stainless steel. Today, the market is flooded with Indonesian nickel, causing prices to plummet. The least profitable mines are closing, while the world's second-largest exporter, New Caledonia, is mired in a political and social crisis.
  • As for Mexico, it is the world's largest silver producer, and the extractive economy continues to grow in the country despite reservations about political stability and worker safety in cartel-controlled territories.

Companies in the sector Diversified giants

As we have already pointed out, since the sector is present in different markets in different parts of the world, large market capitalizations dominate. Backed by a diversified portfolio, they limit risk and can embark on new projects to ensure their long-term survival. Here, our selection is based on companies whose main activity is metal extraction; we therefore exclude other players who extract oil, gas or coal (notably Glencore , whose extraction represents only 37% of its business).

Impossible not to mention the world's largest mining group. Operating all over the world, but mainly in Australia, the company has a highly diversified portfolio, mainly in copper, iron, nickel and coal. BHP's fiscal year runs from July 1 to June 31, so the company has already published its annual results for 2024. BHP had a PER of 18.3x in 2024, high compared with its peers, mainly due to its external growth policy. In particular, the company intends to absorb Anglo American, capitalized at over $37 billion.

Some figures for 2024:

  • EBITDA: $29.0 bn
  • PER: 18.3x
  • ROCE: 27.2
  • Net debt: $9.1 bn
  • Capitalization: $148 bn

Rio Tinto is the world's second-largest mining company by market capitalization. Listed on the FTSE 100, its business portfolio includes iron, copper, aluminum and other mineral sands. According to analysts, Rio Tinto is more stable than BHP, taking fewer risks in its management decisions. This is reflected in its low net debt for the sector ($4.2 billion). Rumors resurfaced at the beginning of the year of a possible merger with another giant, Glencore. This project failed a few years ago.

Some figures from last year:

  • EBITDA: $23.9 bn
  • PER: 12.1x
  • ROCE: 20% OF SALES
  • Net debt: $4.2 bn
  • Capitalization: $148 bn

Brazil's Vale is one of the world's largest metallurgical groups. Its main activity is in ferrous metals, and the company also mines a number of minerals and precious metals such as nickel, cobalt and copper. The company also owns and operates railroads and sea terminals to facilitate the export of its products.

Some figures from last year :

  • EBITDA: $17.9 billion
  • PER: 8.7x
  • ROCE: 14.6
  • Net debt: $9.5 bn
  • Capitalization: $68 bn

Zijin Mining is China's largest diversified mining company. It is engaged in the mining and smelting of gold, copper, zinc and other metallic mineral resources. However, with the support of the Chinese government, the company is pursuing an aggressive and environmentally unfriendly strategy. Its activities in the DRC and Serbia have been heavily criticized. Finally, its net debt is very high, with a Debt/EBITDA ratio of 3.43, well above the industry average.

Some figures from last year:

  • EBITDA: CNY 322,284 bn
  • PER: 14.4x
  • ROCE: 11.44
  • Net debt: CNY 123,387 bn
  • Capitalization: CNY 322,284 bn

Pure players

Mining pure players, specialized in the extraction of a single type of metal, can suffer a variety of fates depending on market fluctuations. When demand for their specific metal is strong and prices high, these companies can enjoy particularly prosperous times. However, their specialization can also make them vulnerable. A fall in prices mechanically leads to a drop in performance, even if they increase their volumes.

Agnico Eagle Mines Limited is a Canadian-based gold mining company that produces precious metals from operations in Canada, Australia, Finland and Mexico. The company is paying 23.2x earnings this year, riding the wave of soaring gold prices. Its share price has risen by 56% since January 1, 2024, with forecast sales up 22.8% on 2023.

The NYSE-listed Australian company is a global producer of lithium chemicals. It holds various patents in lithium extraction processes, including direct lithium extraction (DLE). DLE is the most environmentally-friendly method, with over 90% water recycling. However, with lithium prices plummeting, the company's share price has fallen by 65% since January, despite higher volumes and sales in Q2.

Emerging markets

Mining companies in emerging countries, often supported by protectionist government policies, can enjoy a significant competitive advantage. These policies may include subsidies, import restrictions or preferential tariffs, designed to foster local development and protect domestic industry.

TBP is part of the Harita Group conglomerate and occupies a privileged position in nickel processing and mining in Indonesia. Equipped with HPAL technology to produce an intermediate product of nickel and cobalt, necessary for the manufacture of lithium-ion batteries, the company hopes to benefit from the growth of the electric vehicle market. What's more, TBP enjoys the support of its government, which taxes and blocks nickel exports from foreign operators.

South Africa's leading producer of gold and precious metals, the company mainly mines platinum-group metals. The decline in sales of electric cars in favor of hybrids should give an unexpected boost to demand for platinum-group metals (used to clean exhaust gases) should benefit the company in addition to soaring gold prices. In addition, the company intends to diversify its portfolio into lithium with its mine project in Finland. Nevertheless, the company reported a loss of $2 billion after taking write-downs of $2.6 billion on its US mines, a nickel operation in France and a gold mine in South Africa. It is expected to return to profitability in 2025.

  • Europe's small player

Finally, there are very few mining operations in Europe. Mining on the continent offers limited growth prospects due to high labor costs. Nevertheless, companies with a presence in Scandinavian countries or with a diversified business portfolio operating abroad can do well despite their low capitalization.

The only French mining company historically present in nickel, Eramet has made an interesting strategic repositioning in lithium in Argentina. Penalized by the tense situation in New Caledonia, where it operates, and in Indonesia, where its export permits have been blocked, Eramet was able to build on its recent leadership position in manganese after a hurricane destroyed Australia's largest mine, owned by South32. This small-cap company is doing its best to continue growing, in line with economic cycles. EBITDA is expected to exceed one billion euros by 2025, and the company is discounted by around 30% compared with its peers.

Indexes

First of all, let's break the ice and answer the pertinent question an investor might ask: why invest in a mining company when I could invest directly in listed metals? The answer is simple: mining is a business, and therefore offers a return! Investing in metals generally provides a good hedge against inflation, but mining companies also deliver yield. The average annual dividend of large valuations is around 5%. Here are two index-tracking ETFs for exposure to the mining sector:

  • SPDR S&P Global Mining : this ETF replicates the index of the same name, made up of the largest valuations in the mining sector, with a beta of 1.207 relative to the S&P 500. Fees are 0.35%, with assets under management of $1.7 billion.
  • Amundi STOXX Europe 600 Basic Resources : this tracker tracks the index exposed to the entire European industrial and mining sector. The index has a beta of 1.261 relative to the STOXX Europe 600. PEA-eligible, fees are 0.3% for assets under management of 89 million euros.
  • Vanguard Australian Shares Index ETF: this ETF, which replicates the Australian S&P/ASX 300 index, is a good compromise between excellent geographic and sector diversification, with a significant weighting of the mining sector in its index (around 19%). Fees are 0.07%, with assets under management of 10.3 billion euros.

As you can see, the mining sector is a demanding one for investors. It requires both knowledge of a specific market and an overview of the global macroeconomic context. Operating in a mature and low-growth market - with the exception of certain specific metals such as lithium - mining companies are confronted with high operating costs, fluctuating raw material prices, regulatory compliance and geopolitical risks. However, the sector is certainly full of nuggets. Mining is the lifeblood of the industry, vital to all economic sectors. A thorough understanding of it can represent a great diversification opportunity for seasoned investors.