Beyond the downturn: A focus on financial discipline and innovation in Canadian mining www.pwc.com/ca/canadianmine 2 administration and political upheaval in the European Union—along with a possible increase in interest rates—could see the gold price go up. Commodity prices remain a key uncertainty ahead. Many are starting to bounce back after the long downturn, including coal, iron ore and copper, as demand rises again in China. Copper in particular had a very exciting year and bounced back after a five-year decline. Bolstered by the new US administration’s economic policies, optimism in the Chinese economy and unusual commodity fund opportunities, copper is on track to finish 2016 up over 20% year on year. Other base metals such as nickel and zinc have also had a very good year—with zinc hitting an eight-year high in 2016 and nickel showing strong signs of recovery. Looking into 2017 and beyond, expect to see a growing reliance on new technologies that digitize and automate processes. Barrick Gold Corporation’s deal with Cisco Systems Inc. to improve productivity and efficiency by embedding technology in every aspect of the mining process serves as a prime example. The mine of the future will embrace innovation and non-traditional ideas to overcome challenges and achieve success. The sector may also see new players from other industries enter the mining business, trying to redefine mining in segments such as lithium. Whether “Tesla Motors or other nonmining companies make a bigger play in the mining sector…that’ll be the key indicator of whether the incumbents will still rule the mining sector in 15 years’ time,” Fitzgerald says. The top priority for Canada’s large mining companies going into 2017 will be capital allocation, directing money to the right projects and advancing them with the necessary funding in place, says Liam Fitzgerald, PwC’s Canadian Mining Leader. It’s also important that companies retain lessons learned over the last few years about prudence, resilience and financial discipline. Large miners with international operations also need to carefully manage their jurisdictional risks. “Diversified miners will need to be careful regarding choices about where capital is deployed in terms of both commodity and jurisdiction,” Fitzgerald says. “They’re going to have to continue to make sure costs are managed and balanced with geopolitical risk.” The sector ends 2016 in a stronger position than it began the year, after significant equity and debt investment began flowing into Canadian projects again in the second half of the year. Gold prices are currently going down due to physical sales of gold by ETFs, as the US administration is seen as business friendly, buttressing the US dollar. Looking ahead, continued economic uncertainty with the change in the US Challenges and opportunities Liam Fitzgerald National Mining Leader, PwC Canada Contents About this report In the following financial analysis (market capitalization and cash) all figures are in Canadian dollars unless otherwise noted. The results of companies that report in a currency other than Canadian dollars have been translated at the closing Canadian dollar exchange rate for the respective year. The results aggregated in this report have been sourced from financial results published for the twelve-month period ended June 30, 2016. Beyond the downturn is one of four 2016 publications from Canadian mine looking at the current realities and priorities for public mining companies headquartered in Canada. It also offers a summary of financial analysis of the Top 25 listings, by market capitalization, on the Toronto Stock Exchange (TSX) and complements our 2016 Junior mine report, which analyzes the top 100 listings on the TSX Venture Exchange (TSX-V), and the Global mine report, which looks at the world’s top 40 mining companies. 2 Challenges and opportunities 3 Highlights and analysis 7 Transaction of the year : Centerra and Thompson Creek 8 Alamos Gold: Looking past short-term volatility 9 McEwen Mining: Forecasting $5,000 an ounce but exercising the law of discipline 10 Canadian miners’ attitudes and priorities are changing 11 Adapting well in volatile times An interview with Liam Fitzgerald, Canadian Mining Leader, PwC Beyond the downturn: A focus on financial discipline and innovation in Canadian mining | Canadian mine 2 Beyond the downturn: A focus on financial discipline and innovation in Canadian mining | Canadian mine 3 TSX: The big picture The 230 mining companies listed on the TSX made up 11% of the market’s total $2,596 billion market capitalization as of August 31, 2016. That figure represented a 3% increase in the relative weight of the sector from a year earlier, even as the number of mining companies listed decreased by 12%. The market data highlights the importance of mining to the Canadian economy. In the 12 months ended August 31, 2016, and despite gold prices dropping lately, the market capitalization of all 230 miners increased by 44%, crushing the 8% gain racked up by the overall market. Mining stocks led all industries in terms of trading volumes in the first eight months of the year, with activity almost twice as high as that of the No. 2-ranked oil and gas sector. The impressive rally in the price of gold was one of the most significant drivers of valuations. Sixty percent of the mining companies listed on the TSX have exposure to gold, whose value gained as much as 22% by the middle of the year, as investors sought a haven in the face of global economic uncertainty. “There are enough problems out there to make people anxious,” says Rob McEwen, Chair and Chief Owner of McEwen Mining Inc. “Whether it’s in the Ukraine or in the China Sea, historically, when you see those types of uncertainties coming into the market, people start looking at hard assets.” Highlights and analysis Volume traded on TSX by sector (As of August 31, 2016) Billion shares 0 5 10 15 20 25 ETF Clean technology Comm. & media Life sciences Real estate Closed-end funds Diversified industries Forest products & paper Oil & gas CPC/SPAC Financial services Mining Technology Utilities & pipelines 1 7.2 2.0 0.3 5.2 24.7 1.4 4.9 13.8 1.5 0.02 0.4 1.4 2.2 Sector Source: https://www.tsx.com/resource/en/1387/mi-g-report-august-2016-en.pdf Market capitalization by sector of the total TSX (As of August 31, 2016) 28% 20% 11% 11% 8% 7% 4% 4% Technology Forest Products & Papers 1% 3% Life Science 1% Financial Services Utilities & Pipeline Comm. & Media Diversified Industries Oil & Gas Mining ETF Real Estate Clean Technology & Renewable Energy 1% Closed-end funds 1% Beyond the downturn: A focus on financial discipline and innovation in Canadian mining | Canadian mine 4 The majority of the mining companies on the TSX have market capitalizations of less than $150 million, but the majority of value rests with the bigger players worth more than $1 billion. That data shifted slightly during the year in favour of the large caps. Industry consolidation helped reduce the number of TSX mining companies by 32 in the 12 months ended August 31, 2016. Tahoe Resources Inc.’s $945 million purchase of Lakeshore Gold Corp. and OceanaGold Corporation’s $856 million acquisition of Romarco Minerals Inc. stand as two examples. The decline in listings was partially offset by six new mining listings, each of which graduated from the TSX-V. These include NexGen Energy Ltd., Jaguar Mining Inc., Columbus Gold Corporation, Euromax Resources Ltd., Largo Resources Ltd. and Nemaska Lithium Inc. But there was no significant IPO activity during the period, leaving some to wonder whether deal flow could pick up in 2017 with the US elections finally settled. Highlights and analysis Total market capitalization by group of companies ($ billion CAD) 150M > 0 1B > 150M > 1B 0 50 100 150 200 250 Aug. 31, 2015 Aug. 31, 2016 5.7 27.7 156.3 7.2 24.6 241.9 Average market capitalization per company ($ billion CAD) 0 1 2 3 4 5 6 0.03 0.40 5.58 0.05 0.44 5.26 150M > 0 1B > 150M > 1B Aug. 31, 2015 Aug. 31, 2016 Number of companies by market capitalization (As of August 31, 2016 and 2015) >1B 150M > 0 1B > 150M 300 250 200 150 100 50 0 Aug. 31, 2016 Aug. 31, 2015 128 56 46 170 64 28 Beyond the downturn: A focus on financial discipline and innovation in Canadian mining | Canadian mine 5 The Top 25 Five companies broke into the top tier with explosive growth driven by rising prices of precious metals. The new entrants to the Top 25 are: Pan American Silver Corp., First Majestic Silver Corp., OceanaGold Corporation, Alamos Gold Inc. and Torex Gold Resources Inc. Among the other 20 companies, 11 saw their valuations more than double over the 12-month period. Although at least 17 of the top 25 miners on the TSX have exposure to gold, it’s more than just gold prices that are driving valuations. Cash flow analysis shows the largest companies are focused on operating cost reductions, restoring balance sheet health and continued disciplined capital allocation. To help implement this strategy several companies have increased investment in technology and innovation to improve efficiencies and reduce risks. Highlights and analysis The Top 25 had net cash outflows from financing activities for the 12 months ended June 30, 2016, compared with net cash inflows for the preceding 12 months. Barrick Gold Corporation, Teck Resources Limited and Goldcorp Inc. led the way in repaying significant quantities of debt. Turquoise Hill Resources Ltd. proved an outlier, bringing in US$4.4 billion from a project financing facility to fund its Oyu Tolgoi underground mine in Mongolia. The facility, one of the largest in the mining industry in the last few years, comes from a syndicate of banks and export credit agencies representing the governments of Canada, the United States and Australia. The Top 25 also cut back on outflows for investing activities. The 19% reduction speaks to management’s efforts to dispose of non-core assets, refocus on core properties and restrict capital expenditures to projects that have proven internal rates of return. Top 25 total market capitalization ($ billion CAD) 250 200 150 100 50 0 210 152 Aug. 31, 2016 Aug. 31, 2015 Cash flow analysis for the top 25 Canadian mining companies ($ million CAD) Net cash provided by operating activities Net cash (used in) provided by financing activities Net cash used in investing activities $41,174 $40,448 ($18,716) ($23,336) ($2,200) $2,179 June 30, 2016 June 30, 2015 (20,000) (10,000) 0 10,000 20,000 30,000 40,000 1. Barrick Gold Corporation 2. Potash Corporation of Saskatchewan Inc. 3. Agrium Inc. 4. Goldcorp Inc. 5. Franco-Nevada Corporation 6. Agnico Eagle Mines Limited 7. Silver Wheaton Corp. 8. Teck Resources Limited 9. Turquoise Hill Resources Ltd. 10. First Quantum Minerals Ltd. 11. Kinross Gold Corporation 12. Tahoe Resources Inc. 13. Detour Gold Corporation 14. Yamana Gold Inc. 15. Cameco Corporation 16. Lundin Mining Corporation 17. Pan American Silver Corp. 18. New Gold Inc. 19. B2Gold Corp. 20. Eldorado Gold Corporation 21. Centamin plc 22. First Majestic Silver Corp. 23. OceanaGold Corporation 24. Alamos Gold Inc. 25. Torex Gold Resources Inc. Top 25 companies (As of August 31, 2016) Beyond the downturn: A focus on financial discipline and innovation in Canadian mining | Canadian mine 6 Highlights and analysis Transactions The economic downturn has reduced the tolerance level for risk in the industry at the same time as geopolitical volatility has been on the rise. As a result, many mining companies are looking to diversify their portfolios, adding assets in markets considered relatively stable— such as North America and parts of South America—to offset the risks of projects in more troubled locations, including many regions of Africa. Centerra Gold’s acquisition of Thompson Creek Metals Co. tilted its centre of gravity back to North America and had an added benefit of diversifying its holdings to include copper and molybdenum. But adding geographical diversity or mineral diversity through acquisition only makes sense when the deal brings clear savings through synergies. Alamos Gold Inc.’s merger last year with AuRico Gold Inc., for example, delivered annualized cost savings of more than twice what management had forecasted. Disposition of non-core assets has been another theme across the industry recently, as companies act on promises of more disciplined capital allocation and reducing debt balances. Barrick Gold Corporation, for instance, has sold a number of non-core holdings over the last twelve months to help finance debt repayments of US$3.9 billion. Some mining companies that still face weak commodity prices continue to focus on consolidation. Potash Corp. of Saskatchewan’s and Agrium Inc.’s proposed merger to create the world’s No. 1 producer of potash (expected to close mid-2017) is a prime example of this trend and is a transaction to watch over the coming months. Beyond the downturn: A focus on financial discipline and innovation in Canadian mining | Canadian mine 7 Transaction of the year Centerra and Thompson Creek Darren Millman CFO, Centerra Gold Inc. An interview with Darren Millman, CFO, Centerra Gold Inc. “For Centerra, one of our key objectives was to diversify our portfolio. We felt that Thompson Creek provided that opportunity to us. Darren Millman, CFO, Centerra Gold Inc. ” Even before Centerra Gold Inc. management learned about the financial troubles at Thompson Creek Metals Co. Inc., it knew it wanted to diversify its portfolio. The Toronto‑based company’s key asset, the Kumtor gold mine in the Kyrgyz Republic, was profitable but carried political risk. Centerra has reduced some of that risk with projects in Ontario, Turkey and Mongolia. In 2015, for example, it formed a joint venture with Premier Gold Mines Ltd. for joint ownership and development of the Greenstone Gold Property in the Geraldton-Beardmore Greenstone belt in Ontario. But it was Centerra’s decision to buy Thompson Creek for US$1.1 billion, announced last July, that’s proving truly transformative. “For Centerra, one of our key objectives was to diversify our portfolio. We felt that Thompson Creek provided that opportunity to us,” says Darren Millman, the Chief Financial Officer. “Having this asset brings our strategic objectives forward by 18 months.” One outcome of the innovative deal is that Centerra’s business is now more equally weighted between riskier operations overseas and the more stable setting of North America. Up to 2014, Thompson Creek’s management had focused on molybdenum production. When the company went on the auction block, potential buyers considered it a copper play, but Centerra looked at the company as a gold asset, especially its Mount Milligan mine in British Columbia. To help deliver on that vision, Centerra renegotiated the terms of a metal streaming agreement that Thompson Creek had with Royal Gold Inc. at Mount Milligan. Royal Gold’s approximately 52% gold streaming interest at Mount Milligan was changed to a 35% gold stream and approximately 19% copper stream. Centerra executives performed extensive due diligence of Thompson Creek’s molybdenum assets to learn how the business works and what were the liabilities and cash flow scenarios. They concluded that the molybdenum business unit provides additional opportunity when market prices rebound. The company will operate the molybdenum business on a cash flow neutral basis until that time. Centerra financed the acquisition by combining a new US$325 million senior secured term loan and revolver facility, a CA$170 million bought deal and utilization of US$400M in Centerra cash. The financial arrangement leaves the company well positioned to make additional acquisitions to further diversify its assets. “We do retain a strong balance sheet. If an opportunistic deal comes our way, we’ll look at it, but we need to ensure that we remain financially strong,” Millman says. Beyond the downturn: A focus on financial discipline and innovation in Canadian mining | Canadian mine 8 Alamos Gold Inc. Looking past short-term volatility Jamie Porter CFO, Alamos Gold Inc. An interview with Jamie Porter, CFO, Alamos Gold Inc. “The benefits of diversification are that if one asset is underperforming, the others can be outperforming to make that up, and we’ve seen that throughout this year.” Jamie Porter, CFO, Alamos Gold Inc. A year and a half after merging with AuRico Gold Inc., the new Alamos Gold Inc. is focused on insulating itself as best as possible from the unpredictable forces that define so much of the sector. With three operating mines in North America and exploration and development projects that extend to Turkey, the intermediate-sized miner is carefully building a diversified portfolio of assets to reduce risk. “The benefits of diversification are that if one asset is underperforming, the others can be outperforming to make that up, and we’ve seen that throughout this year,” says Jamie Porter, Alamos’ Chief Financial Officer. The merger, in July 2015, brought together the Young-Davidson mine in northern Ontario and the Mulatos and El Chanate mines in Sonora, Mexico. The company has more than $1 billion invested in Young-Davidson and has spent the year ramping up its underground mining rates and bringing the asset to its full potential. The mine became free cash flow positive in the second quarter of 2016—essential piece of Alamos’ strategic plan. “We’re looking at generating sufficient free cash flow from our existing producing assets to be able to self-finance our development pipeline. We have a total of six development projects and over 10 million ounces in that pipeline,” Porter says. “Most of the new assets that are coming online are effectively old mines that are being recycled into new,” he says. “There was a lack of exploration investment in the recent downturn in the precious metal commodity cycle, and the result of that has been there’s a lack of growth projects.” Change is needed across the industry to find smart ways to meet tomorrow’s demand; companies with shrinking reserves will need to come up with innovative new ways to find or process gold in order to succeed, he says. A similar approach is needed for sustainable mining practices, Porter says, adding that Alamos focuses on a concept it calls “net benefit.” “While we recognize that mining can have an impact on the environment, we look at all our stakeholders, the job creation and the economic benefits that we provide to the communities where we operate. We try to make that equation result in a net benefit for our stakeholders.” The company’s philosophy is to “question everything” and reject a lot of industry practices. For instance, it seeks to avoid relying on third parties, such as banks, for helping finance growth. It’s already trying to create a balance sheet that will withstand the next economic downturn, even as it moves ahead with investments for its mines and exploration projects. More than 60% of its reserves are located in Canada, an unusually high amount. And it is determined to control the timing and pace of its developments, rather than fall victim to the gyrations in the price of gold. One challenge the company has set for itself is to keep hitting operational targets while reducing capital spending. The medium-term plan is to have a strong enough balance sheet to enable Alamos to be an aggressive deal maker if there’s another downturn. The merger last year left the company with an experienced integration team. It has also produced annualized savings of at least $22 million, more than twice the amount promised to shareholders in 2015, and allowed management not to worry unduly about short-term volatility in the price of gold. Nobody knows what the price of gold will be in the short term, Porter says, but he’s optimistic that in the longer term prices will move “substantially higher.” He bases his outlook on what he sees as a scarcity of good assets. Beyond the downturn: A focus on financial discipline and innovation in Canadian mining | Canadian mine 9 McEwen Mining Inc. Forecasting $5,000 an ounce but exercising the law of discipline Robert McEwen Chairman and Chief Owner, McEwen Mining An interview with Robert McEwen, Chairman and Chief Owner, McEwen Mining Inc. “Two thousand [dollars an ounce] is an easy shot. I’m beyond that. I’m up at $5,000.” Robert McEwen, Chairman and Chief Owner, McEwen Mining Inc. The Chair and Chief Owner of McEwen Mining is extremely optimistic about gold prices, but he’s less certain whether base metals will follow the precious metal’s lead. Monetary stimulus, fears of more terrorist strikes and geopolitical risk in Ukraine and the South China Sea are just some of the volatile forces that will drive investors to gold as a haven, says Rob McEwen. “Two thousand [dollars an ounce] is an easy shot. I’m beyond that. I’m up at $5,000.” Base metals also have some inflationary macro forces behind them, including rising populations and China’s historic move from a rural to urban society. Copper, zinc and other metals could ride a wave of renewed demand, but large clouds loom on the horizon. If governments turn recent political rhetoric about protecting domestic jobs into trade protectionist policies, the free flow of goods and services around the world will stop and metal prices will suffer. In addition, if China fails to manage its huge credit bubble effectively, demand for base metals will tumble, he says. McEwen looks back on the economic downturn and credits the success of his own company during that time to a clean balance sheet, rising product which companies can access capital at favourable rates in the future. There’s US$2.2 trillion invested directly by index funds in S&P 500 stocks and another US$5 trillion of index money benchmarked against the S&P 500, he explains. Membership in the index brings a more stable shareholder base and a lower cost of capital. For now, Newmont Mining Corp. is the sole gold stock on the index. “If portfolio weightings in gold move back to where they have been in the past, of up to 5%, then you’re going to have a huge flow of money going in, and that’s where our competitive advantage will come from,” McEwen says. from its mines and a disciplined approach to spending. “It’s about how you keep delivering value to the share owners, rather than to management that is concerned about its job,” he says, adding that he owns 25% of McEwen Mining’s shares. One outcome of the downturn has been a greater sensitivity to geopolitical risk, be it terrorists roaming through parts of Africa or capricious governments eating away at mines’ profits. Outside of North America, McEwen favours South America over most of Africa and is particularly enthusiastic about Argentina. After a year in power, the new government has proved itself to be business oriented, removing regulations, devaluing the currency and removing export taxes. “I was down there [recently] and met with the President and his Senior Ministers. It’s a very different mood, a very encouraging mood. So we’ll just have to see if they can sustain it. But right now their popularity level remains high. So that’s a very good sign and I think people should be looking at Argentina more,” he says. Index funds and exchange-traded funds are fundamentally changing the equity markets and will have a big impact on Beyond the downturn: A focus on financial discipline and innovation in Canadian mining | Canadian mine 10 Canadian miners’ attitudes and priorities are changing David Greenall Director, PwC Canada An interview with David Greenall, Director, PwC Canada “There’s a fundamental need to work with First Nations to address the value that’s inherent in the mineral resource, in terms of sharing between the community and the mining company. David Greenall, Director, PwC Canada ” A growing commitment by the Canadian mining industry to sustainability, ethics and climate issues in its decisionmaking process is helping define the sector’s future. “The mine of the future will be one that, first of all, optimizes that nexus of energy, water and waste in a way that creates maximum value for the company, but also influences a shared value relationship with local communities,” says David Greenall, a Director in our consulting group on sustainability. “It will also be one that is low carbon and resilient to extreme weather.” In the past, mining companies have shown a reluctance to introduce significant changes to their business models. But that’s now changing, especially among the larger players. Investors are partly responsible for the mind shift, as they assess how well companies are managing their risk profiles. The severe downturn in commodity prices has also played a role, leading the mining industry to adopt new principles and practices in an effort to reduce costs by optimizing their production processes. That means finding better ways to use energy and water and handle waste. Alternative fuels and renewable energies, for example, are starting to displace higher carbon fuels such as diesel. Wind, Most of these companies’ operations are either on, or in proximity to, First Nations or Aboriginal communities, and mining executives have learned the best accords are shared value arrangements, which may involve employment for the community, skills training or local suppliers. “There’s a fundamental need to work with First Nations to address the value that’s inherent in the mineral resource, in terms of sharing between the community and the mining company,” he says. The progressive shift occurring across the mining industry is playing out first in Canada, but as companies apply evolving values and principles to their businesses, they will apply them to their operations around the globe. “I have seen a commitment by our biggest companies to define the values and the principles they adhere to and apply [them] across their operations, irrespective of where they have operations,” Greenall says. solar and small hydro energy installations are becoming increasingly prevalent on mining sites. “Whether you call those sustainability issues, or just simply management excellence, it’s the same thing,” Greenall says. The sector’s expanding use of technology is a critical part of the shift, with some companies employing it to bring continuous transparency to their operations in the form of real-time monitoring and reporting of on-site activities. In many cases, the result is more positive, trusting relationships with local community groups. A sharper focus on sustainability has led to efforts to enhance resilience to extreme climate patterns, such as floods and damaging winds, so companies can minimize disruption to their operations. “There’s greater understanding of the direct business impact [of] the increased incidence of, and magnitude of, extreme weather events, largely precipitation related, and what that means in terms of operational disruption,” Greenall says. As they reassess principles and processes, many of the country’s largest miners are putting a greater emphasis on productive relationships with local communities, especially First Nations. Beyond the downturn: A focus on financial discipline and innovation in Canadian mining | Canadian mine 11 © 2016 PricewaterhouseCoopers LLP, an Ontario limited liability partnership. All rights reserved. PwC refers to the Canadian member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. 259107 1216VN www.pwc.com/ca/canadianmine Adapting well in volatile times Liam Fitzgerald Partner, Canadian Mining Leader 416 869 2601 email@example.com connect on linkedIn Dean Braunsteiner Partner, Ontario Mining Leader 416 869 8713 firstname.lastname@example.org Mark Platt Partner, B.C. Mining Leader 604 806 7093 email@example.com connect on linkedIn Nochane Rousseau Partner, Quebec Mining Leader 514 205 5199 firstname.lastname@example.org connect on linkedIn James Lusby Partner, Assurance 416 365 8181 email@example.com connect on linkedIn Mark Patterson Partner, Assurance 604 806 7160 firstname.lastname@example.org connect on linkedIn Marelize Konig Partner, Assurance 416 814 5862 email@example.com connect on linkedIn Calum Semple Consulting Partner, Global Mining Consulting Leader 416 815 5325 firstname.lastname@example.org connect on linkedIn Stephen Mullowney Partner, Corporate Finance, Mining 416 687 8511 email@example.com connect on linkedIn Contacts Additional contributors Monica Banting Senior Manager, Assurance Kelly Baudru National Marketing Manager Facundo Meyniel Manager, Assurance Shauna Peck Senior Marketing Manager Michael Fairbairn Associate, Assurance Mika Bott Senior Graphic Designer Beyond the downturn highlights an industry in better shape than it has been in several years, with investment beginning to flow back into strategic acquisitions and capital projects as we near the end of 2016. Many of the gains have been driven by gold, although certain base metal prices have begun to rally. However, the future remains unclear as there is a possibility that significant political and economic uncertainty around the world could translate into downward pressure on commodity prices in 2017. But the positive takeaway from this report is that many companies are adapting well to these volatile times by imposing disciplined capital allocation, making savvy deals, rebalancing their portfolios for risk and employing new technology and innovations to improve performance and safety. Our “Shaping the mine of the future” campaign aims to showcase some of the best and most creative solutions being applied by mining companies to not only survive in uncertain times but to prosper. To start the conversation, talk with your local PwC mining professional or visit pwc.com/ca/mining.