Why Capital Structure of Mining Companies Matters


". . .not all mining companies are created equally."

Mining companies represent a compelling opportunity for investors with very long time horizons. Everything I have written about so far has been centered on this point. However, not all mining companies are created equally. Some companies didn't manage themselves financially as well as others throughout the gangbuster times and are now facing harder times relative to their peers. If you are considering investing in the mining industry, it is a very good idea to consider how the company of interest has been managing its finances over the last several years.

Last year should have made just about every CFO in the world take out their old text books to review the Modigliani-Miller theorem in order to review proper capital structures. Most business models that relied extensively on debt financing were destroyed in 2008, and those not officially destroyed in 2008 are going to be struggling for the foreseeable future. I am not sure that debt-driven business models will ever come back, let alone come back in the next 10-15 years.

In an article by The Economist titled "Digging Deep" published on Feb 5th, the author points out that several mining companies are rushing to raise equity. According to the article, the firms together are aiming to raise as much as 17 billion dollars, which will result in "lopping a fair chunk from their combined net debt of $62 billion dollars."

Not all companies are in the predicament of raising equity to pay down debt. Even though I am a long-term buyer of this sector, I do not believe all companies are created equally. Thus, I believe investors need to use a fine tooth comb in their examination of how these companies have conducted themselves in the good times, as well as bad.

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