Emerging risk - Wage inflation is a real threat to corporate profitability in developing economies
Investing in emerging markets carries both risk and reward and the former was vividly illustrated in the full-year results published on 8 August by Aquarius Platinum, which owns one mine in Zimbabwe and five in South Africa. As we noted in Platinum is losing its shine, however, all but one of the South African mines have had to be mothballed because they are unprofitable at today’s platinum price.
Even so, while the platinum price may have declined slightly this year, it is still approximately double what it was in 2009. This increase encouraged the South African miners to seek pay rises Aquarius was unwilling to pay, resulting in the events described in one of the more striking paragraphs you are likely to read in any company’s results and which is worth quoting in full.
“On 1 August 2012 a very serious security incident occurred at Kwezi shaft, a production unit at the Kroondal PSA near Rustenburg in the North West Province. A gathering of approximately 200 people, some of whom were armed, forced their way onto the mine property. Members of the private security company under contract to the mine attempted to disperse this unruly crowd as the actions of the group, which included the throwing of petrol bombs, threatened both mine employee lives and property. A total of 450 employees were on the shaft and underground at the time of this invasion. Six people died and at least 20 others were injured in this incident. The people are understood to be former employees of the mine’s mining contractor, who were dismissed following illegal strike action in June 2012.”
As it turns out, this was only a precursor to the tragic events of 16 August when South African police opened fire on striking miners at a nearby mine, killing 34 people. That mine, which is owned by commodities giant Lonmin, has effectively since shut down, with fewer than 7% of staff reporting for duty and violence continuing between duelling mine unions who are fighting each other at the same time as picketing in pursuit of a tripling of pay from the mine operators.
This sad series of events highlights two issues facing companies and investors in emerging markets, the first of which is that, no matter the potential rewards, there are risks associated with any involvement in countries where legal processes and business practices may be more extreme. This consideration is also affecting Aquarius in Zimbabwe, where it is in negotiations to sell half of its other open mine to the Zimbabwean government. It seems improbable the final price will favour Aquarius.
It also illustrates how (and why) average wages in emerging markets have been rising steadily in recent years. They will not go back to prior levels – that genie is never going back in its bottle – and this means the costbase of Aquarius and numerous other businesses has been altered for ever. Attempts at curbing salary increases thankfully do not often end in mobs, petrol bombs and shootings but they are never popular.
Cost inflation has been extreme in the mining industry because profitability has been extreme and while some costs are easy to claw back, others are not. That means, for commodity producers to be able to stay profitable, commodity prices need to be permanently higher than their long-term average and it remains to be seen whether that is possible on an ongoing basis.
Fund Manager, Equity Value
I joined Schroders in 2000 as an equity analyst with a focus on construction and building materials. In 2006, Nick Kirrage and I took over management of a fund that seeks to identify and exploit deeply out of favour investment opportunities. In 2010, Nick and I also took over management of the team's flagship UK value fund seeking to offer income and capital growth.
The views and opinions displayed are those of Ian Kelly, Nick Kirrage, Andrew Lyddon, Kevin Murphy, Andrew Williams, Andrew Evans and Simon Adler, members of the Schroder Global Value Equity Team (the Value Perspective Team), and other independent commentators where stated. They do not necessarily represent views expressed or reflected in other Schroders' communications, strategies or funds. The Team has expressed its own views and opinions on this website and these may change.
This article is intended to be for information purposes only and it is not intended as promotional material in any respect. Reliance should not be placed on the views and information on the website when taking individual investment and/or strategic decisions. Nothing in this article should be construed as advice. The sectors/securities shown above are for illustrative purposes only and are not to be considered a recommendation to buy/sell.
Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.