Bearish Commodity Markets Mean It's Time To Look At Inventory, Working Capital

by: MetalMiner

By Lisa Reisman

In bearish metal commodity price cycles (many of you must be tracking copper markets), clever companies seize process efficiencies to boost bottom line results. For large mining firms and producers shipping billions of dollars worth of goods around the world, the ability to shave one day or even as much as 7 days can yield an enormous financial benefit. And we all know that by reducing inventory levels, companies can improve their financial performance.

But what does that actually look like in the mining industry? Let's start with the weighted average cost of capital (WACC). Its technical definition appears as follows, "A calculation of a firm's cost of capital in which each category of capital is proportionately weighted." For us non-financial types it essentially equates to a company's average cost to borrow.

In international trade terms, we could apply the WACC to say, the cost of an entire shipment. The simple formula looks something like this, a model we ran back in 2008 but have since updated:

Inventory carrying cost = cost of shipment x (a company's cost of capital/365 days) x number of days of carry (For global sourcing use 45-60 days).

The 45-60 days equates to the average shipment time of goods/raw materials etc. leaving the mining company/producer/manufacturer to the final delivery point (obviously many trade routes are far shorter than that).

Now let's take this calculation to a mining company. Let's say the average dollar value of an iron ore shipment is $30m. For payment at site terms and an 8% WACC, the equation looks like this:

Inventory carrying cost = ($30m x 8% = $2.4m/annum)/365 = $46,027/day

Working with trade automation provider Bolero, a mining firm sought to shave 7 days from the trade cycle using trade automation software. With $5b of annual shipments, the business case for moving toward an automated solution becomes incredibly attractive, considering the above referenced equation!

On the flip side, one might think an importer would oppose trade automation because it would require the importer to pay earlier. However, knowing with certainty that the right documents are always in the right place at the right time allows an importer to substantially pare back inventory. Although the physical supply chain works well, the paperwork, or rather missing paperwork, creates a bottleneck and forces importers to have extra inventory on hand to cover potential shortages.

In the words of a large iron ore importer in China, "I don't care about paying earlier -- I'd rather not have the extra stock." Bearish commodity markets mean the time is ripe for pursuing process efficiencies that unlock working capital and have a near immediate effect on the bottom line.