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Anglo’s fire sale offers little value

Anglo American is addressing the painful position it has found itself in, but hopes of a rapid turnaround now look overdone and the shares have run too far ahead of this painful reality
August 4, 2016

In February, Anglo American (AAL) was staring into the abyss. Not only had the market failed to buy into the radical restructuring plan announced by the miner just weeks before, but commodity prices were still in a slump and Anglo's credit rating had been downgraded to junk. Since then, and somewhat incredibly, the stock has been one of London's biggest risers.

IC TIP: Sell
Tip style
Sell
Risk rating
Medium
Timescale
Long Term
Bull points
  • Profitable De Beers division
  • Share price momentum
Bear points
  • Continued weak commodities outlook
  • Selling assets at the bottom
  • Shares valued at huge premium to assets
  • Huge debt pile

There are a number of technical reasons for this, including a slight recovery in metal prices and the decision of many market players to close their short positions in mining stocks, but for Anglo American the rally now looks overcooked. Put simply, this bull case places too much optimism in value-accretive asset sales and iron ore and copper prices, while overlooking the variable quality of Anglo's assets. With the shares at their highest point in a year, we think it's worth cashing out.

 

 

Despite its name, Anglo American is mainly concentrated in South America and South Africa, and is the world's largest producer of platinum and diamonds, the latter thanks to its 85 per cent stake in De Beers. It is the smallest of the four large diversified miners listed in London – the others being BHP Billiton (BLT), Rio Tinto (RIO) and Glencore (GLEN) – but in recent years sought to muscle in on that pack through the costly and much-delayed development of the Minas-Rio iron ore project in Brazil. Since 2007, Anglo pumped more than $13bn (£9.8bn) into the site, twice the original budget, leaving its balance sheet terribly over-stretched when commodity prices sank. By the end of 2015, net debt stood at $12.9bn, while Minas-Rio – whose production was now surplus to global supply – had provided just over one year of output.

Management realised it needed to completely re-shape the company. Chief executive Mark Cutifani announced Anglo would cut two-thirds of staff, abandon its dividend and focus the business on just three areas: copper, platinum group metals and diamonds, with an immediate target of reducing net debt to $10bn by the end of 2016. The stock's ascent suggests the market has bought into this plan. Jeremy Lang, a partner at Ardevora Asset Management, accurately describes the debt reduction plan as evidence "management knows changes need to be made, or the company will face extinction". He also says Anglo's intention to offload risk constitutes a "value opportunity", at least in relation to the less indebted, more capital-committed Rio Tinto.

Of course, offloading risk is not a straightforward process, especially when there is a limited market for your assets. For iron ore, tepid industrial demand from China is unlikely to raise prices significantly above the cost profile of Minas-Rio and its South African Kumba mine, the latter of which could bring the added headache of industrial strife in the event of an asset disposal. And while early reports suggest Anglo's Australian coking coal assets could fetch around $1.5bn, a sale would wipe out a key source of comparatively resilient earnings. The $1.2bn price-driven impairment booked against these assets in last week's half-year results suggests Anglo is preparing to offload assets at a heavy discount.

The market also seems to have forgotten that a mining company cannot just exist to reduce its borrowings. Put simply, that money has to come from somewhere, and in Anglo's case it is likely to be at the expense to the capital expenditure and working capital needed to maintain the asset base. In the six months to June, annual capital expenditure dropped by $1bn to $1.1bn year-on-year, including falls in the long-term core portfolio. And while a decline in expansionary expenditure is understandable, sharp drops in 'stay-in-business' and development costs could start to wear at the asset base, even if Anglo has been able to eke out some cash cost savings.

ANGLO AMERICAN (AAL)

ORD PRICE:862pMARKET VALUE:£ 11.1bn
TOUCH:861.6-862.1p12-MONTH HIGH:868pLOW: 216p
FORWARD DIVIDEND YIELD:NAFORWARD PE RATIO:431
NET ASSET VALUE:1,272¢NET DEBT:56%

Year to 31 DecTurnover ($bn)Pre-tax profit ($bn)Earnings per share (¢)Dividend per share (¢)
201431.04.51174.085.0
201523.01.6364.032.0
2016*20.21.2440.0nil
2017*20.10.372.0nil
% change-1---

Normal market size: 3,000

Matched bargain trading

Beta: 1.72

*Liberum forecasts, adjusted PTP and EPS figures

£1 = $1.32