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Good call – Why businesses ought not to ignore how their actions affect their wider industry

25/09/2015

Andrew Lyddon

Andrew Lyddon

Fund Manager, Equity Value

Ask anyone to list the various factors that motivate companies and their management teams and ‘the greater good’ is unlikely to feature anywhere near the top. With our latest look at platinum and the companies that mine it, however, we will illustrate why businesses ought not to ignore how their actions may affect the wider industry in which they operate.

The last time we visited the platinum sector, in Testing metal, things were looking pretty bleak and it would be tough to argue they have improved in the six months since. Platinum’s price has continued to fall to such an extent that much of the industry is now operating on the basis the precious metal costs more to mine than it can be sold for. That is a bad place for any mining company to be.

At this point, an obvious course of action would be for platinum companies to stop mining the stuff as, that way, at least they would not be losing money and it might well help the supply/demand imbalance. With the exception of the closure of the odd loss-making mine and some scaling back of investment, which could redress that imbalance in the longer term, there are few signs of that happening, however.

This can be attributed to the unfortunate dynamic where management teams think narrowly about what appears to be best for their business in the short run rather than what could be best for the industry – and by extension their business as a part of that industry – over the longer term. As a result, rather than scaling back production, some of the bigger players have been taking action to edge it up.

Giving into temptation

Thus, for example, Impala Platinum, the second largest producer in the world, has been looking to raise money that will both underpin its balance sheet and allow it to increase production that would otherwise have tailed off. Having spent a lot of money building some new shafts, the company has given into the temptation to spend more to finish off the mines – and, it hopes, some competition.

Taken in isolation, spending money with the aim of producing more platinum and so easing the great impact of one’s fixed costs is not necessarily a bad plan. The trouble is, if everybody adopts the same plan independently in the hope of being better off, you just end up with more platinum being produced than is needed. This means the industry as a whole is not better off and so nobody is better off.

This instinct to carry on investing in the hope each new injection of cash will be the one that gives you that crucial edge over your rivals is by no means restricted to the commodities sector – with the airline industry a notable practitioner. It is a particularly tough trick to pull off as a commodities business, however, because what you are selling is, by definition, wholly identical to what all your rivals selling.

Until quite recently, there was a possibility the platinum sector’s supply issue would be eased by Anglo-American, the world’s largest producer, having to shut some very unprofitable mines. In the end though, the group agreed to sell off these operations to South African miner Sibanye, which seems unlikely to have bought them just to run them down for the benefit of the wider platinum industry.

Hard times

So while the deal may well prove to be a good one for both parties – Anglo-American has removed some loss-making mines from its books while Sibanye has picked up some cheap assets – it ultimately does nothing to address those concerns about an oversupply of platinum. What it does do is illustrate the sort of behaviour that comes into play when these sorts of high-fixed-cost industries hit hard times.

Even though the low platinum price is almost certainly, at some level, connected to the fact there is too much supply for today’s level of demand, nobody wants to cut production. Perhaps today’s level of demand is depressed too – though there seems little evidence for that – and perhaps the inventories of platinum that had been built up ‘overground’ are being worked down more than people realise.

No doubt the world will adjust – for example, a weakening rand against the dollar should serve to make an industry that is largely based in southern Africa more competitive. Furthermore, mining businesses can always look to put pressure on their suppliers to cut costs or, where the political situation allows it, to scale back their own labour costs through greater mechanisation.

Thus far, however, the behaviour of the larger platinum miners, which ultimately have to take responsibility, is not necessarily suggestive of an industry doing a lot to help itself. Of course, this hugely challenged sector contains some startlingly cheap investments – and indeed we own some – but there are few better case studies of what a mining sector can look like when it is in a very bad place.

Author

Andrew Lyddon

Andrew Lyddon

Fund Manager, Equity Value

I joined Schroders as a graduate in 2005 and have spent most of my time in the business as part of the UK equities team. Between 2006 and 2010 I was a research analyst responsible for producing investment research on companies in the UK construction, business services and telecoms sectors. In mid 2010 I joined Kevin Murphy and Nick Kirrage on the UK value team.

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