Industry Top Trends 2021...risk profile Revenue decline – 2021 vs. 2019 EBITDA decline – 2021...

S&P Global Ratings 1

Industry Top Trends 2021 Metals And Mining Resilient Demand From China Improves The Industry Outlook

What’s changed? The pace of recovery will vary across commodity markets and regions. We expect it could take until 2022 for industrial activity to return to pre-pandemic levels. China’s rebound provides an improved outlook for upstream miners.

Ratings are more stable than in 2014-2016. Investment-grade miners have been resilient due to robust financials and the rapid rebound in Chinese demand.

Volumes are down, but not by as much as we expected. Lower supply, as well as the return of Chinese demand, have supported iron ore prices.

What are the key assumptions for 2021? Prices are bouncing back with supply cutbacks and improving demand. Prices are rebounding sharply from pandemic-induced lows, as producers quickly cut output while demand only paused. A weaker U.S. dollar should support higher base metal prices, but could also point to lower precious metal prices.

Volume pickup is still a year away. Even with COVID-19 vaccines, demand from the auto, aerospace, oil and gas, and commercial construction industries is unlikely to return to 2019 levels in 2021.

Financial discipline supports credit metrics. Issuers appear poised to extract better returns from selective corporate development after a few years of restraint.

What are the key risks around the baseline? Wobbles in Chinese demand. China’s influence is a double-edged sword. Demand drove price recovery, but new lockdowns could impact this. Reinvigorated trade issues between China and the U.S. could also reduce infrastructure spending.

Currency swings. We see a risk that currency appreciation dampens domestic sales for metal processors in 2021.

Environmental, social, and governance (ESG) factors. Access to capital is becoming increasingly challenging for metal companies with poor ESG profiles.

December 10, 2020

Authors Simon Redmond London +44 207 176 3683 simon.redmond @spglobal.com Flavia Bedran Sao Paulo +55 11 3039 9758 flavia.bedran @spglobal.com William Ferara New York +1 212 438 1776 bill.ferara @spglobal.com Minh Hoang Sydney +612-9255-9899 minh.hoang @spglobal.com Danny Huang Hong Kong +852 2532 8078 danny.huang @spglobal.com Elad Jelasko London +44 207 176 7013 elad.jelasko @spglobal.com Donald Marleau Toronto +1 416 507 2526 donald.marleau @spglobal.com Diego Ocampo Buenos Aires +54 11 4891 2116 diego.ocampo @spglobal.com

Industry Top Trends 2021: Metals And Mining

S&P Global Ratings December 10, 2020 2

Ratings trends and outlook Global Metals and Mining Chart 1 Chart 2

Ratings distribution Ratings distribution by region

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Ratings outlooks Ratings outlooks by region

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Ratings outlook net bias Ratings net outlook bias by region

Source: S&P Global Ratings. Ratings data measured at quarter end. Data for Q4 2020 is end October, 2020.

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Shape of recovery Table 1

Sector Outlook Heatmap

Sensitivities and structural factors Shape of recovery

COVID-19 sensitivity

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business risk profile

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combined Moderate None Neutral 0%-10% >=2019 2023 2021

Upstream Low None Neutral 0%-10% >=2019 2023+ 2021

Downstream High Low Neutral 0%-10% >=2019 2022 2022

Source: S&P Global Ratings. The figures in this table are composites and some blend different dynamics. This is especially true of the “Credit metric recovery to 2019 levels” column.

Leverage has increased in 2020 for the combined portfolio, but this is not universally the case for gold and iron ore producers, which have enjoyed very strong prices. Consequently, as our price assumptions trend down from 2020 for gold and iron ore, 2021 will be a weaker year for gold and iron ore companies than 2020.

Companies’ low debt and leverage in 2019—which were a source of credit strength in 2020—mean that their metrics may not recover to such strong levels at all. However, this need not be negative if these companies can maintain their positions within the respective rating thresholds. For this to happen, the metrics don’t necessarily need to recover to their strong 2019 levels.

S&P Global Ratings believes there remains a high degree of uncertainty about the evolution of the coronavirus pandemic. Reports that at least one experimental vaccine is highly effective and might gain initial approval by the end of the year are promising, but this is merely the first step toward a return to social and economic normality; equally critical is the widespread availability of effective immunization, which could come by the middle of next year. We use this assumption in assessing the economic and credit implications associated with the pandemic (see our research here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.

This report does not constitute a rating action.

http://www.spglobal.com/ratings



Metals And Mining Ratings trends and outlook

With the regions of the world at different stages of recovery, the pandemic’s impact on the commodity markets will vary

The pandemic had a significant impact on industrial activity, global steel markets, and downstream producers in 2020. Although the world is still emerging from the pandemic, and far from resuming full-blown industrial production, we see a vastly improving outlook for most metals going into 2021. However, the road to the recovery and the potential for prolonged economic weakness remain a key source of uncertainty. This could undermine growth, weaken market sentiment, and increase volatility in commodity prices.

Gold and iron ore remain notable exceptions after they recently reached historical peaks. Gold continues to shine amid uncertainty about the economic outlook and a weaker U.S. dollar. After being the first country to enter an extended lockdown, China’s ramp-up of industrial activity following the height of the pandemic has caused Chinese steel demand to resurge in a supply-disrupted market, driving iron ore prices to six-year highs.

Indian companies were not in a good position going into the pandemic, as domestic demand was already slowing down. Leverage was high as companies continued spending on organic growth projects or acquisitions of distressed steel assets while cash flows were subdued.

Our main assumptions for 2021 and beyond

1. Higher prices signal a possible emergence from the trough

Prices for most metals have shot up since mid-2020, owing to a mix of market-based cutbacks, unexpectedly buoyant demand, and pandemic-driven closures. For example, steel producers in the U.S. reduced output almost 20% by mid-2020. On the other hand, we assume moderating gold and iron ore prices in 2021. The recovery in global growth should support industrial metal prices in general, although supply and market dynamics differ.

2. Metal producers are at risk of more intense competition

Higher prices due to a sudden drop in supply benefits the lowest-cost and highest-rated issuers. A protracted downturn in volumes, however, could hit vulnerable assets and speculative-grade issuers in a way that deepens their competitive disadvantages, particularly for steel and aluminum. If volumes remain below 2019 levels beyond 2021, some capacity closures in North America and Western Europe could become permanent, because more profitable and better-funded competitors will build new capacity in that timeframe, and this could replace aging assets.

3. Better returns on investments and controlled credit risks could prompt more acquisitions

Five years of spending restraint since the last sharp downturn in 2014-2016 is giving way to guarded optimism. Some miners are contemplating increasing capex to replace depleting reserves, while mini-mill steel producers in the U.S. and elsewhere aim to displace aging blast furnaces. M&A appears disciplined, with little appetite for higher debt to fund equity premiums, at least so far.



Higher prices signal a possible emergence from the trough

Lower demand and prices for mined base metals like copper and iron ore usually prompt quick reductions in production. This is because contractors of the smaller marginal assets that produce such metals can adjust costs and outputs more nimbly. Higher-cost production on generally steep cost curves shut down quickly and enabled a quick price response. For example, copper prices, which are sensitive to small changes in fundamentals, have bounced back to a five-year high after falling twice in 2020, once as the pandemic hit China, and then again as the virus spread globally (see chart 7). The price of copper spent about eight weeks below $2.50 per pound, which we believe was a catalyst to stop about 10% of output that was likely making cash losses at those prices.

Restarts in steel and aluminum will take longer than mined metals because of persistent global overcapacity. The American Iron and Steel Institute reports that steel production in the U.S. was down 18% year on year through Nov. 28, 2020. It can take months to ramp production down and then back up, so a rebound in demand has brought operating rates back above 75% in late 2020 from 67% so far this year, which could mark a turning point for earnings and cash flow. Profitability in steel and aluminum has been in a longer downturn, with demand dropping throughout 2019. By the time the pandemic hammered global GDP in early 2020, many assets were near cash breakeven, which prompted aggressive cutbacks. Metal demand has been more robust than we expected through the first three-quarters of 2020, especially in China. That said, emerging pandemic risks for winter in the northern hemisphere could disrupt a sustained improvement in volumes and prices through 2021. Tighter capex programs in recent years could lead to some capacity constraints over the medium and long term. Finally, the longstanding inverse relationship between the U.S. dollar and metal prices could be a tailwind if the dollar retraces its gains during the pandemic.

Gold prices are dropping as better news on COVID-19 vaccines clears some uncertainties. The correlation of gold prices with the U.S. dollar, interest rates, inflation, and oil goes some way to indicating the price direction. For example, the decline in gold prices has tracked the decline in the U.S. dollar in the past few months, while rising oil prices as a barometer of economic recovery bring their relationship with gold prices back toward a historical norm. We use a declining price assumption for gold in our credit analysis over the next few years, because we expect these historical relationships to normalize after the pandemic.

Chart 7

Gold, copper and iron ore prices

Source: S&P Global Ratings.

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Metal producers are at risk of more intense competition

Overcapacity remains a structural problem for the steel industry. This is most likely to have a negative impact on higher-cost producers, especially in North America and Western Europe. The downturn hit most steel producers outside China hard in the second quarter of 2020. Without the subsequent market rebound, the financial and rating implications could have been worse. Prompt capacity closures removed supply from the market, but when this production returns will be important for the resilience of prices and margins in 2021. See our recent report, “The Shape of Recovery for Global Steel Depends On ABC: Assets, Balance Sheets, And China,” published on Dec. 1, for more detail on market dynamics and ratings. If volumes remain below 2019 levels beyond 2021, some capacity closures in North America and Western Europe could become permanent, because more profitable and better-funded competitors will build new capacity in that timeframe, and this could replace aging assets.

Better returns on investments and controlled credit risks might prompt more acquisitions

After curtailing capex on the back of the pandemic and the prospect of lower demand in the coming years, capex appears to be picking up, but companies remain disciplined in their use of debt. We don’t exclude more growth-oriented capex, depending on outlook for commodities. Coming into the 2019-2020 downturn, the industry’s debt leverage was lower than in previous cycles, mostly because of spending restraint since 2015 and a renewed focus on returns over growth. Such restraint, particularly in mining, has already resulted in a tight market that could be exacerbated if there is a broad upswing in demand. This could occur in 2021 if metal demand strengthens more than we anticipate. In addition, limited equity-funded M&A has bolstered some business mixes, in the steel industry, for example, and highlights companies’ reluctance to use debt to fund takeover premiums that have often destroyed value. Some selective M&A activity may continue. Lastly, we view the current very low interest rates and the availability of liquidity as allowing some weak companies to continue their operations, rather than becoming potential distressed targets.

Credit metrics and financial policy The prudent financial policies that many companies adopted in response to the last major downturn in 2014-2016 have stood them in good stead in 2020. These policies—including limits on debt and leverage, as well as shareholder distributions—are likely to remain a credit strength in 2021. The strong iron ore prices and elevated gold prices during the current global downturn mean that this year’s severe global economic recession hasn’t been a harsh test for most producers of those commodities, or their financial policies. The majority of large and midsize companies entered the recession with very healthy balance sheets, limited capex commitments, and flexible dividend policies. Even though these companies didn’t need to change their short-term objectives, some took the opportunity to reduce their spending and waive dividend payments (see chart 8).

This resilient performance was not the case for many smaller, less diversified companies, those without exposure to iron ore or gold, and particularly downstream companies. Here, cash flows and credit ratios deteriorated due to the pandemic’s impact on prices and volumes. Nonetheless, the weak results in 2020 did not translate into a wave of downgrades or even negative outlooks. The rebound in demand and prices in the second half of 2020, which we expect to continue in 2021, means our multi-year credit-metric forecasts should return to rating-commensurate levels. This assumption is also supported by the headroom companies had in early 2020, and their ability to generate positive free cash flow during the trough of the cycle. We note that many of the companies remain committed to deleveraging, and the 2020 downturn has provided them

https://www.capitaliq.com/CIQDotNet/CreditResearch/SPResearch.aspx?DocumentId=46687711&From=SNP_CRS




with another incentive to accelerate the process. As a result, the appetite for acquisitions or greenfield investments—which was already low before the pandemic—may dwindle even further for many in the next two-to-three years.

Chart 8

Ratings evolution of five big miners

Source: S&P Global Ratings.

In 2020, many companies also arranged and tapped into larger bank lines to bolster liquidity, even if many have subsequently repaid them. We note that, once companies had attained a prudent amount of leverage in recent years, iron ore prices and disposals allowed for significant returns of cash to some shareholders, in line with their financial policies.

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S&P Price Revision (Downwards) S&P Price Revision (Upwards)BHP Vale Rio TintoAnglo Glencore



Key risks or opportunities around the baseline

1. Demand from China could weaken

China’s demand could be affected if: 1) the country is hit by a second wave of the pandemic, leading to additional lockdowns; 2) domestic demand doesn’t fully recover to pre-pandemic levels; and 3) an improvement in China’s trade relationship with the U.S. under the new administration and amid the recovering global economy may reduce the Chinese government’s spending on infrastructure, which could weaken base metal prices.

2. Currency swings will continue to affect margins and cash flows

Non-U.S. miners have enjoyed margin improvements and capex reductions owing to weaker domestic currencies, but as fiscal and monetary stimulus measures are withdrawn in their home countries, currencies may appreciate against the U.S. dollar. More so, if the elected administration in the U.S. expands fiscal stimulus and this weakens the dollar further. For metal processors that compete with imports, a weak dollar may exacerbate competition.

3. ESG factors will play a decisive role in future capital allocation

Since the metals and mining industry is perceived as posing multiple threats to the environment, companies may increasingly see their access to capital restrained. That is already a reality for coal miners and coal-fired steel processors. The use of cleaner energy sources, the reduction of greenhouse gas emissions, the correct treatment and disposal of waste, as well as active engagement with the surrounding communities, are all paramount to the industry. Markets and end users will demand timely data on those fronts and miners’ future performance will play a major role in investment decisions and business continuity.

Demand from China could weaken

China was hit the hardest by the pandemic during February and March 2020, as GDP contracted 6.8% year on year in the first quarter. Subsequently, China has pretty much contained the pandemic, and economic activities are nearly back to normal, especially industrial activities, evident from a GDP expansion of 4.9% in the third quarter year on year. Yet there are still local outbreaks, and the pandemic has resurged globally in recent weeks. At this point, we haven’t incorporated the full effects of a full-blown second wave into our macroeconomic estimations or into our price assumptions, but the risk of that is rising.

Lockdown measures in China were completely removed by the third quarter, and that triggered a strong response in demand and metal prices. For instance, Chinese crude steel production surged by 10% year on year in the third quarter, compared to 1.6% and 2.8% in the first two quarters respectively. But such high growth is unlikely to continue through the whole of 2021.

Although the policy stance of the new U.S. administration remains to be seen, a Biden government is unlikely to worsen the trade relationship between China and the U.S., in our view. Moreover, with COVID-19 vaccines on the horizon, we expect a global economic recovery from 2021. If the international trade environment improves, China can rely less on infrastructure investment to support the economy. However, China’s “dual circulation” initiative aims at focusing on domestic demand, thereby reducing the country’s reliance on volatile international demand.



Currency swings will continue to affect margins and cash flows

Much of the credit protection for miners’ earnings in 2020 came from the depreciation of their domestic currencies. This was due to a combination of factors, including governments’ monetary and fiscal stimulus measures, which weakened currencies. Because of that, and the fact that inflation has remained fairly low, export-oriented companies such as miners saw their profit margins expand and capex decline, as profit margins and capex are measured in U.S. dollars—typically the functional currency for miners. Metal processors also experienced the same uplift, although less immediately, as metals are sold domestically in local currencies, and even when domestic prices correlate with international prices, there is a lag in the adjustment of domestic prices depending on the strength of demand.

We believe that governments in 2021 will seek to reduce the supply of money to control inflation rates, and this might allow for some currency appreciation. On top of that, the value of the U.S. dollar would dip with a new large fiscal stimulus. Reinvigorated trade flows and stimulus packages are likely to maintain price momentum across the metal spectrum, so a weak dollar doesn’t represent a large threat for miners, especially those that mine metals with a clear negative correlation with the U.S. dollar, such as gold and silver. But currency swings are a factor to consider, especially if prices do not hold as strongly as we expect.

ESG factors will play a decisive role in future capital allocation

Some perceive the metals and mining industry as a necessary evil from an environmental perspective, and companies need to raise the bar consistently in their management and disclosure of ESG standards. In our view, some highly polluting sectors, such as coal mining and coal-fired metal processors, are at a clear disadvantage in terms of access to capital and face serious business-continuity risks in the medium term. The Democrats’ win in the U.S. presidential election could exacerbate this situation.

Increasing numbers of investors have announced divestments of thermal coal-related assets, and more and more financing institutions are refraining from providing capital to coal or coal-fired projects. For example, BlackRock Inc. announced in March 2020 that it will divest its actively managed investments in companies that obtain more than 25% of their revenues from thermal coal by mid-2020.

Yet we see this as more of a trend in developed markets, given their generally higher awareness of environmental protection; slower growth, if not a decline, in energy demand; and greater affordability of renewable energy, which is more expensive to produce than nonrenewable energy. On the other hand, despite the rising awareness of environmental issues in developing markets, they face the practical question of how to support economic growth with affordable energy.

Related Research – The Shape of Recovery for Global Steel Depends On ABC: Assets, Balance Sheets, And

China, Dec. 1, 2020 – SLIDES Published: Commodities 2020: Global, Russian, And CIS Rating Trends, Nov.

16, 2020 – Economic Research: A Double-Digit Rebound Has Begun, But It's No Time To

Celebrate, Oct. 6, 2020 – S&P Global Ratings Lifts Price Assumptions For Most Metals, Sept. 24, 2020 – Coal Sector Faces Tightening Access To Capital As Demand Dynamics Weaken, Aug.

17, 2020 – ESG Industry Report Card: Metals And Mining, Feb. 11, 2020











Industry forecasts Global metals and mining Chart 9 Chart 10

Revenue Growth (local currency) Capex Growth

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Debt / EBITDA (median, adjusted) FFO / Debt (median, adjusted)

Source: S&P Global Ratings. Revenue growth shows local currency growth weighted by prior-year common-currency revenue-share. All other figures are converted into U.S. dollars using historic exchange rates. Forecasts are converted at the last financial year-end spot rate. FFO—Funds from operations.

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Source: S&P Global Market Intelligence, S&P Global Ratings calculations. Most recent (2020) figures use the last 12 months’ data.

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Industry Top Trends 2021...risk profile Revenue decline – 2021 vs. 2019 EBITDA decline – 2021...

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