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Has Tesla Solved Mining Companies’ Capital Budgeting Dilemma?

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Dec. 11 2017, Updated 7:31 a.m. ET

Capital budgeting

Mining companies are generating significant free cash flows amid higher commodity prices. Looking at the oversupply situation for most metals, there aren’t many assets for which miners would like to allocate capital. Metals such as iron ore and aluminum are still plagued with oversupply. To make things worse, some of the previously planned iron ore mines, including Vale’s (VALE) S11D, are ramping up production. In energy (XLE), many companies may not want to loosen their purse strings given the uncertainty over long-term demand amid vehicle electrification.

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Cash flows

While mining companies’ cash flow situations have improved significantly over the last few quarters, the avenues for capital allocation may be limited. Some believe that the safest way miners can handle their capital budgeting is to return cash to shareholders or repay debt. The growth-hungry equity markets might also want miners to invest in growth projects (SPY) (SPX-INDEX).

Electric vehicles

Could electric vehicles (or EVs) like the ones sold by Tesla (TSLA) possibly solve mining companies’ capital budgeting dilemmas? Several leading diversified miners are looking for assets to position themselves as suppliers to the EV market. Mining companies are looking at lithium, cobalt, and copper assets for EVs. Copper has attracted mining companies Rio Tinto (RIO) and BHP Billiton (BHP), given the expected supply deficit.

However, it’s worth noting that mining companies haven’t been reading the markets perfectly. Iron ore could be a case in point where leading miners invested heavily, expecting Chinese demand to grow further. But as Chinese steel demand moderated, we’re left with a significant iron ore overcapacity.

Could the EV trend also go the way of iron ore? We’ll look at that in the next part.

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