Mining Investment: A Guide to Understanding Valuations

While other businesses and industries focus on market potential and competitive advantages, success in mining – or, more accurately, the ability to create value for investors– depends on distinct factors such as resource quality, location, commodity pricing, and operational efficiency. Understanding these fundamental differences enables successful investors to adopt specialized approaches to valuation — approaches that capture mining’s unique characteristics.

Mining companies create value in different ways at different stages, from initial mineral discovery through development, and ultimately, production. Earlier-stage value lies in identifying and proving mineral deposits. During development and production, value depends on the ability to extract minerals economically. At any stage, several key factors and characteristics influence valuation, most notably:

• Mining projects must operate where the minerals are found
• Product prices are generally set by global markets
• Resources – and business lifespan – are finite
• Most importantly, mines require significant upfront investment including years of exploration and development before generating any revenue

This article examines how these characteristics impact mine project valuation. Starting with the fact that mining is a commodity business, we’ll look at the physical characteristics that drive project value, how projects are developed and financed, and ultimately, how to build appropriate valuations that capture these unique aspects.

Market & Product Fundamentals

Most businesses compete by creating new markets or disrupting existing ones. They typically succeed by developing innovative products, building strong brands, or offering unique services.

Mining is different. Mining companies generally produce commodities — standardized products that are essentially identical, regardless of who mines them. An ounce of gold is an ounce of gold, whether it comes from Ghana or Nevada. This means mining companies can’t differentiate through product features or brand recognition. They also can’t set their own prices; they’re “price takers,” selling their products at whatever the global market dictates.

That said, not all mining companies produce saleable metal, in many instances the saleable product is a concentrate, with biproducts and impurities that attract both premia and discounts from buyers that process the concentrate into final metals or chemicals at different locations from the mine. This value chain complexity leads to some opacity in pricing and works against standardized price for homogeneous products. It doesn’t always work out that way, particularly as the mining and chemicals industries grow closer together, notably in the battery metal subsector of the industry.

Since most mining companies can’t differentiate through their products, they must find other ways to create value by increasing volumes, recoveries or purities; lowering costs and pursuing innovative ways to find and recover more ore from deposits. This can mean discovering and developing new deposits to drive growth, implementing more efficient mining and processing methods, or optimizing operations to reduce costs. Scale matters, because fixed costs can be spread across more production, driving down per-unit costs — a factor that must be carefully quantified in any mining valuation analysis.

Unique Characteristics of Mining Projects

Most businesses can choose their location based on factors like market access, labor costs, or tax advantages. Mining companies, however, must operate where mineral resources are found. However convenient it would be, you can’t relocate a copper deposit from Kazakhstan to Canada.

Reliance on a fixed location means companies must carefully evaluate jurisdictional conditions before investing. Even projects with excellent geology need favorable regulatory environments, significant infrastructure, and stable social conditions to succeed. These factors can have a tremendous impact on project value and development timelines.

Another fundamental characteristic that sets mining projects apart from most businesses is their finite life. Every tonne mined reduces the remaining mineral reserve; eventually, the entire economically viable portion of the resource will be depleted. Even before depletion, profitability can vary dramatically from year to year – not necessarily due to poor performance but by design. Some years require mining through more waste material to access valuable ore, while in other years they may be able to access higher-grade zones more easily. Market-driven commodity price fluctuations add another layer of variability, as companies may adjust production rates or focus on different areas during low-price periods. This combination of planned and market-driven variability makes standard valuation methods difficult to apply.

Obviously, a key component of valuing a mining company is also based on commodity pricing forecasts. Resource Capital Funds utilizes a proprietary commodity assessment model to forecast specific commodity prices. Commodity markets are not homogenous. Each commodity has its own supply/demand dynamics and other macro factors that drive pricing and ultimately mine company valuations.

Valuation is also affected by mining environmental restoration and mine closure requirements. Unlike most businesses, for which closure simply means ceasing operations, mining project plans must include restoring the site after operations end to a post-mining land use agreed with stakeholders. The timing of the work required to successfully achieve this post-mining land use is integrated progressively through the operating life of a mine, at final mine closure and in some cases post-closure (for ongoing monitoring, maintenance and management). The tax treatment of these costs varies by jurisdiction — some allow tax benefits to be claimed as the liability accrues, while others require actual expenditure before tax benefits can be claimed. These differences need to be factored into project valuations.

Mining Project Financing

Mining projects follow a unique financing path. Mining companies typically raise their early money through common equity. The real capital challenge, however, comes after years of work, when feasibility studies to determine economic viability have been completed and permits obtained. At this financing stage, construction funding must be raised to build the mine and on-site processing facility — and these construction costs are often orders of magnitude higher than the costs involved in the study and permit phase.

If the studies are sufficiently promising, debt funding may become available during the construction phase. However, it typically forms just one component of a larger financing package that will include equity (generally common equity) and may also include alternative financing options such as stream agreements, royalties, convertible debt, preferred equity and other solutions where one or more entities pay an upfront fee in exchange for a percentage of the mine’s future production.

A critical consideration is that capital expenditure usually needs to be completely or close to completely spent before the mine can generate any revenue. This creates a distinct risk profile relative to businesses that can begin generating revenue with a much lower upfront investment.

This financing structure means that a pre-revenue mining company might have millions already invested, yet need millions or even billions more before generating any revenue — a situation that would be unusual in other industries. It is not uncommon for a mining company to raise money, become public, grow in value for many years and then be acquired for hundreds of millions of dollars without earning a single dollar of revenue. For this and other reasons, standard metrics like EBITDA multiples, which work well for typical businesses, are not always a suitable method for valuing most mining projects.