A mammoth US$140bn in writedowns have been taken by the mining industry since 2011, according to a report by PwC. Yesterday The Australian reported another round of impairments is likely in August.
Impairments represent an estimate of value destroyed through bad investments. They are often dismissed as ‘non-cash’, as if to suggest they aren’t real losses, and it’s true that there is usually no cash out the door in the year the writedowns occur. Rest assured, the losses are real. Real cash that was wasted in prior years.
Miners have a terrible record of investing shareholders’ money. Rio Tinto’s US$25bn writedown on Alcan stands out as the worst recent example, but it’s far from the only one. Why is this? Four factors in mining conspire to all but guarantee poor returns:
- Cyclical conditions
- Capital intensity
- Long-life assets
- Short term or spot contracts.
Decent returns are unfortunately only earned for a brief part of the cycle. Boom conditions attract too much investment, and then long asset lives mean the oversupply takes decades to clear. The recent downturn isn’t unusual in that respect. Irrespective of timing, it was certain to end with a great glut of supply and plunging prices.
Investors now rightly look to force management to take the walk of shame for bad investing. That’s for the good. Managers shouldn’t be able to just brush bad decisions under the carpet. They should be held accountable so future investments are made with more care.
Value isn’t lost during the bust, it is destroyed during the boom, when capital expenditures and acquisitions are made. But investors are part of the problem, too, and seem to have learned little from experience. They throw cash at management and beg for growth right at the height of the boom. Perhaps fund managers have their own walk of shame to make?
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Forager Funds is a boutique fund manager specialising in a value investing approach. We offer an ASX listed Australian Shares Fund as well as an International Shares Fund both aimed at delivering returns for long term investors.