Bill Kohm

Article Dean Dorton

Here are the key risks and opportunities for 2018:

Technological Modernization

Investment in mining technology has lagged behind the technological advancements of other sectors. These advancements range from automated production and data analysis to advance digital applications, such as artificial intelligence and blockchain technology. Companies willing to invest in new technology or further apply existing technology will be positioned to maximize efficiency and to gain a deeper understanding of their operations through the data that is now available to them. Consider these potential applications:

Data analysis allows a company to examine its performance under various types of weather and then have the ability to implement subtle changes based upon weather conditions that improve productivity

Machine learning applications as equipment transmit operational and geological data in real-time, while at the same communicating with a vendor regarding the operational health of the machine and need for servicing

Production analysis paired with customer profiles to maximize sales

The use of blockchain technology to streamline contract negotiations and provide direct corroboration between inventory warehouses and suppliers

Companies who utilize the tools that technology provides will be well positioned succeed in this sector. Companies who fail to invest in technology run the risk of losing competitive advantages to their competitors.

Shareholder Returns

The mining sector has not been a “hot” area for investors in recent years. Public companies have yielded mediocre results at best and been slow to issue dividends. Private companies have struggled to obtain the pricing and production volume necessary to reward existing shareholders and to entice private investors. Recent trends, such as changes in the American geo-political environment, the increase in metallurgical coal prices, and the increased demand for cobalt (stemming from battery applications), have created an environment of interest to new investors, who may seek quick returns on their investment. This presents the sector with a philosophical paradigm, to invest in the growth of the company or the satisfaction of the shareholders. It will become increasingly important for companies in the sector to balance the growth agenda with disciplined capital expectations.

Cybersecurity

The mining sector is not immune to the digital reformation transforming all other industries. With these changes come significant threats to cybersecurity. Cyber threats have the ability to eradicate gains obtained from any strategic efforts. The influx of artificial intelligence and operational intelligence as a core strategy causes cybersecurity to be a primary risk to the sector. The risk of rogue network operators, “hackers,” puts all digital data at risk.

Cash Optimization

After several years of the mining sector being cash strapped, trends within the sector have recently resulted in positive cash flows. The question now becomes how to put this cash to use: corporate growth versus shareholder awards. The concerns of the shareholders have been discussed previously. A return to growth will drive new revenue and new cost structures, namely an investment in capital. Equipment fleets have become aged as the sector sought to minimize capital expenditures. Deferred maintenance of mature equipment is likely significant as cash resources have been limited. Revenues will continue to be highly volatile and susceptible to unexpected market fluctuations.  Companies within the mining sector must be intentional in their utilization of cash, balancing the needs of today with investment in the future.

Regulatory Changes

Regulatory and political issues are a significant consideration within the sector. Nations are seeking accountability over the extraction of their natural resources while at the same time seeking to be business friendly in order to maximize tax revenue. This creates an intense regulatory environment. States and localities are advancing tax regulations that create additional cost and administrative burden. Public policies continue to promote renewable energy sources, thus decreasing demand. Environmental agencies can block or hamper access to strategic mining areas. Certain regulations threaten the way in which extracted minerals are used, thus decreasing demand. Changes to the regulatory environment can lead to uncertainty within the sector; it is very important to stay abreast of such changes. American miners start 2018 with lower income tax rates which afford them the opportunity to invest back into their businesses. Owners may also look at stock buyback opportunities. The new tax act allows for 100% bonus depreciation for five years which encourages capital investment. Mining companies may be able to improve employee benefit packages as well to help retain key employees. Lastly, miners should look to move operations back to the U.S. from foreign locations to take advantage of the better tax landscape.

Social Awareness

The mining sector must seek to proactively engage the local and regional communities in which it operates. Miners have a unique role in the local, state, and national community. The safety of its workers should always be a priority for mining companies. Miners must consider the impact of their actions within each unique community. Illegal or unethical practices will damage a miner’s reputation and make national headlines, but legitimate closing of a project due to financial reasons may generate significant reputational damage as well. Miners should consider the impact their operations have on their communities.

Operational Runway

Years of focusing on survival led many companies to minimize costs, resulting in exploratory efforts being drastically reduced. As such, many companies in the sector may have limited operational runway, meaning limited access to ongoing or future mining areas. Extending this runway becomes a key risk. Key factors include expanding the exploration budget, utilizing contract miners, studying existing areas under control, and forming strategic alliances with competitors or others within the industry.

Changing Fundamentals

This risk will only rise in severity. The mining sector is a mature component of the global economy. As social preferences change and new technologies become available the status quo of the mining sector becomes irrelevant. The future of coal becomes increasingly uncertain as natural gas took a significant portion of coal’s use in energy production. Now, technological advancements are increasing the ability of renewable energy sources to compete with coal and natural gas, depleting coal’s position even further. The current and expected future demand for electric automotives and the potential for the American commuter system to be replaced by a fleet model in the relative near future draw into question the long-term demand of petroleum and the potential demand for minerals used in battery manufacturing such as cobalt. Understanding current and future trends within the sector will be a key to success.

Production Management

Maximizing the economic efficiency of production is a competitive advantage for miners who do it well. Production is impacted by financial, geological, and even social factors. Miners who effectively manage these factors and maximize production in areas that return the most value to their company will experience success. Additionally, miners who invest in maximizing the efficiency of their production abilities will be most prepared to take advantage of market improvements in their industry.

Capital Sources

Certain segments of the mining industry have lost favor with public investors and consequentially, many financial institutions. Traditional financing arrangements are difficult to obtain, and when obtained may come with high fees and interest. Companies should consider alternative capital sources such as international institutions, brokers, and even customers. These alternative capital sources may offer a form of strategic alliance, such as in marketing existing products, or helping to develop additional assets.

Compare to 2017 risks

Article Dean Dorton

The Institute of Internal Auditors (IIA) recently released a report which examines outsourcing of internal audit activity.

Over 50% of North American companies participating in the survey use third parties to support their internal audit functions. The demands of internal audit have increased the prevalence of using third parties. Key aspects of using third parties include:

  • Supplementing staff to address staff shortage or help meet tight deadlines
  • Adding specialized skills including certified fraud examiners, IT specialists and data extraction experts
  • Handling special projects
  • Covering remote locations

IIA clearly states that best practices promote having at least one internal employee handle the oversight of the internal audit function and serve as the liaison with the third party service provider.

At Dean Dorton, we have seen the benefits of working with both private and public companies in a co-sourcing arrangement. Our expertise in a broad range of industries, coupled with our internal audit tools, allows a company to maximize the benefits of an internal audit function. We concur with the IIA’s recommendations to:

  • Think of the stakeholders and how third parties add value to meet stakeholder interests
  • Formalize the arrangement with the third party to establish expectations
  • Establish protocol for remediation and follow up steps
  • Allow third parties to share best practices including risk assessments

For more information, please contact:
Bill Kohm: bkohm@deandorton.com, 859.425.7625
Jim Tencza: jtencza@deandorton.com, 502.566.1071

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Article Dean Dorton

The convenience store (“c-store”) industry continues to show positive returns. The decline in fuel prices has allowed higher margin instore items to have a bigger impact on the overall gross profit. Please take a look at your numbers and see how you compare to this public company group.

2015*

2014

Fuel gross profit %

8.6%

5.9%

Fuel margin $ (per gallon)

$0.21

$0.20

Non-fuel gross profit %

36.6%

33.2%

Overall gross profit %

17.6%

12.4%

% of sales from fuel

68.4%

75.7%

Overall revenue growth

-10.7%

2.7%

12 month return

33.3%

23.8%

 

Note: The group in this study consisted of five publicly traded c-store companies.

* Estimate based on results through September 30, 2015.

For more information, contact Bill Kohm at bkohm@deandorton.com or 859-425-7625.


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Article Dean Dorton

Electric co-operatives are unique entities that are part government agency, part agricultural co-operative, and part not-for-profit company that provide electricity to rural areas of the United States. Most co-operatives are solely distributors of energy and do not actually generate the electricity themselves. Due to the fact that co-operatives are utilities in a largely unregulated sub-section of the energy industry which provide service in primarily rural locations, there are specific risks that need to be addressed. Here are the key risks for 2016:

  1. Cybersecurity
  2. Power Supply Costs
  3. Safety Including Overtime Management
  4. Billing Adjustments (Fraud Risk)
  5. Cash Handling (Fraud Risk)
  1. Third Party Contract Compliance
  2. Employee Benefits
  3. Weather
  4. Succession Planning
  5. Pensions
  1. Cybersecurity
    Co-operatives need to implement a proactive cybersecurity strategy that includes effective controls to prevent and detect cyber-crimes. Employee training regarding potential phishing schemes can be one cost effective preventative control. Potential effects of a cybersecurity breach include shutdown of an energy grid, re-direction of energy to a particular location, or theft of customer data.
  2. Power Supply Costs
    The EPA Clean Power Plan which proposes carbon dioxide limit regulations may result in increased costs of compliance for co-operatives that will either reduce profit margins or be passed on to the end consumer in the form of higher electricity rates. Management needs to investigate alternative sources of energy to further diversify power sources.
  3.  Safety Including Overtime Management
    Safety is a major concern for co-operatives as their employees routinely work in dangerous conditions (i.e. downed power line in a thunderstorm) that, if not taken seriously, can expose the co-operative to unnecessary costs. Monitoring of overtime hours to help ensure employee safety represents an important oversight role and a vital way to control costs.
  4. Billing Adjustments (Fraud Risk)
    Proper segregation of duties needs to be in place to prevent those who initiate billing adjustments from those approving the adjustment. Otherwise, an employee could raise a customer’s rate, remit the proper agreed upon amount, and then pocket the extra amount. Additionally, adjustments involving employee accounts should require a higher level of review.
  5. Cash Handling (Fraud Risk)
    Proper controls should be implemented to protect against fraud regarding the handling of cash. This includes proper segregation of duties around cash collection, accounting module access, reconciliation of the cash balance, and recording the collection in the accounting system.
  6. Third Party Contract Compliance
    Co-operatives engage in numerous agreements with third parties that require oversight. Agreements should be logged and reviewed periodically for compliance. Additionally, management should do an annual review of its third parties to ensure that they qualify as contractors and not employees.
  7. Employee Benefits
    Focus should be placed on compliance with affordable care act provisions. Additionally, a federal overtime proposal exists that salaried individuals who earn less than approximately $50,000 per year be eligible for overtime which will impact labor costs. This overtime change could be in place by 2017, so 2016 is a great time to determine which employees may be impacted by this change and evaluate potential options. Finally, co-operatives should use some creativity in offering benefit programs that appeal to younger generations and emphasize the importance of work-life balance.
  8. Weather
    Distribution co-operatives deliver electricity from the national gridlines to rural counties. In cases of severe weather, utility poles may be damaged and not functioning properly. It may be more difficult to restore functionality in a timely fashion due to the poles’ location in very rural areas. Contingency plans and proper training should be in place to deal with severe weather issues.
  9. Succession Planning
    As co-operative executives continue to grow older and retire in larger numbers than in the past, there must be a greater emphasis on succession planning and staff development. Whether a co-operative decides to use an internal or external hire to replace key top management, steps need to be taken to ensure a smooth transition.
  10. Pensions
    Unfunded pension benefit obligations pose a serious threat to the sustainability of current businesses as they may not have the required cash flow to pay benefits as they become due. Additionally, co-operatives that participate in multi-employer funded pensions may be paying funds that do not ultimately benefit their employees if other participating employers do not contribute the appropriate amount of funding. Management should update its pension obligations at least every other year through a credible actuary and actively discuss key assumptions with the actuary.

For more information, contact Bill Kohm at bkohm@deandorton.com or (859) 425-7625.


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Article Dean Dorton

Owners need to monitor the following risk areas to stay competitive in 2016:

  1. Cybersecurity
  2. Social Media
  3. Volatility of Gas Prices
  4. Mobile Technologies
  5. Food Service Competition
  1. Wage Rates
  2. Regulation Compliance
  3. Asset Theft
  4. Changing Demographics
  5. Increased Fuel-Efficiency
  1. Cybersecurity
    Cybersecurity involves the need to comply with PCI standards to protect cardholder information.
    This also includes skimming, in which devices are placed on pumps to steal credit card information. Procedures should be implemented to monitor the pumps and prevent and/or remove these devices.
  2. Social Media
    Social technologies are increasingly becoming a part of everyday life. Incorporating social media communications into the business model can improve customer service and provide a low-cost alternative to traditional advertising.
  3. Volatility of Gas Prices
    Decreases in gas prices nationwide have led to consumer confidence in the health of the economy, which will also benefit convenience stores with increased sales. However, the converse is true as well: should gas prices significantly increase again, then in-store purchases of snacks and drinks will drop. Additionally, Congress is looking at raising federal gas taxes to fund the nation’s aging highway projects.
  4. Mobile Technologies
    More than half of all buying is expected to occur on mobile devices; therefore, having mobile applications is crucial to achieving success. In addition, these mobile applications will provide ways of saving money and reducing human error.
  5. Food Service Competition
    Convenience stores that don’t invest in food services create the risk of losing out on business. The market for convenience store prepared meals is increasing as consumers desire diverse, affordable, convenient, and healthy food options. Convenience stores are uniquely positioned to meet this growing need if an adequate investment in food service is made.
  6. Wage Rates
    The growing pressure to raise the federal minimum wage will increase the number of part-time workers, so businesses can keep the cost of labor low and avoid certain benefits. Additionally, there is a federal proposal that salaried individuals who earn less than approximately $50,000 per year be potentially eligible for overtime, which will impact convenience store managers and raise labor costs. This change to overtime pay should be in place by 2017.
  7. Regulation Compliance
    There is an increase in regulations in a variety of categories, including e-cigarettes and other vapor products, diet drinks, energy drinks, and dietary supplements. Increased regulation may result in higher prices for those products or a ban on the products altogether. In addition, menu-labeling regulations taking place in 2016 will require increased menu-labeling that will likely cause consumers to avoid lower quality or less healthy food options, thus decreasing food sales. Convenience stores must also comply with regulations regarding sales of alcohol, tobacco, and lottery tickets or face serious fines and penalties.
  8. Asset Theft
    A persistent threat to convenience stores is employee theft of cash from registers and customer theft of inventory from the shelves. Review and monitoring procedures should be implemented to prevent and detect these threats.
  9. Changing Demographics
    The workforce and general population are becoming more ethnically diverse and growing older. Demographics will change dramatically in the future as people live and work longer and as the percentage of other cultures in the U.S. increases. This will affect how convenience stores operate internally and how they reach a much more diverse marketplace.
  10. Increased Fuel-Efficiency
    Vehicles are becoming increasingly fuel efficient, which means fewer stops at gas stations to fill up the tank. This results in fewer opportunities for consumers to visit convenience stores and make purchases. The use of reward programs and other tools are needed to drive inside sales.

Sources:
www.csnews.com
www.nacsonline.com
www.petrolplaza.com

For more information, contact Bill Kohm at bkohm@deandorton.com or (859) 425-7625.

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