As an Aussie, it is hard to avoid the mining industry. Commodities are Australia's largest export and you'll find that around 30% of all companies listed on the ASX are mining-related companies.
Many Motley Fool readers are familiar with the financial side of the industry, however, the operational side is just as important for investors to be aware of. Using my five years of operational experience working as an engineer on mine sites around Australia, I aim to help fill in this gap. This series of articles will give you the key information you need when it comes to evaluating mineral resources companies.
Over the series, we'll cover various commodities, the mining lifecycle, and mining operations. We'll then take a closer look at exploration companies, small to mid-sized producers, large producers and the important considerations when investing in the industry. We'll also run through some examples of successes like Fortescue Metals Group Limited (ASX: FMG) and some not so successful operations to glean the important lessons from those that succeeded and where the failed ones went wrong.
So, what are resources companies?
People often believe that mining operations are simple.
Really, how hard is it to dig a hole in the ground, load the ore onto a ship and sell it? The answer: surprisingly hard and fraught with all kinds of risk.
A recent scan of ASX data indicated that only 10% of these listed mining companies reported a net profit during the past twelve months. Times are often tough for these companies and their employees. Many of the career miners in their 50s and 60s working on mine sites speak of up to five redundancies throughout their career!
A typical mining project will take between 10-25 years from the start of exploration through to first production. Mining companies are exposed to countless and varying degrees of risk. Primarily as a commodity provider, they take the market price and are therefore fully exposed to the boom and bust commodity cycle. The commodity price when a new mine is approved for construction could be dramatically different from that when the mine is operational.
The selection of companies to invest in is diverse, ranging from penny exploration stocks like Walkabout Resources Ltd (ASX: WKT) with a market capitalisation of $4 million through to world giants including BHP Billiton Limited (ASX: BHP) with a market capitalisation of $85 billion.
The following well-known quote attributed to legendary investor Warren Buffett is particularly true in the boom and bust cycle of mining – "A rising tide will lift all boats. It's only when the tide goes out that you see who's been swimming naked."
The rising tide of the mining boom also raised costs in the mining industry. The subsequent commodities price crash has exposed those companies swimming naked as they frantically cut costs to try and survive. It's still no certainty that iron ore miner Atlas Iron Limited (ASX: AGO) will survive over the medium-to-long term. Termite Resources and Western Desert Resources Ltd (ASX: WDR) are two iron ore miners who have already collapsed – as we mentioned here.
A practical understanding of mining operations will help you avoid these unsustainable, high-cost companies and increase your chances of making successful investments in the resources sector.
The next article in this series will introduce readers to Australia's main mineral resources so keep an eye out for that later this week.
In the meantime, The Motley Fool has two free ASX investment recommendations that carry far less risk than a typical investment in the mining industry:
