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Anglo in takeover crosshairs

TIP OF THE YEAR: Anglo American's lowly rating combine with the prospect of operational improvements could attract the attentions of a commodities giant during 2014.
January 2, 2014

It's nearly a year to the day since it was announced that Mark Cutifani would take over the reins at diversified mining giant Anglo American (AAL) . As expected, it hasn't been plain sailing for the former AngloGold Ashanti chief, but we believe that after a protracted period of underperformance, the arrival of Cutifani, together with a renewed focus on restoring margins and driving up free cash-flows, should eventually feed through into improved market sentiment and reverse the trajectory of the shares. In addition, Anglo's current lowly rating has increased the chances that it could be subject to an approach from another resource heavyweight, particularly in light of Glencore Xstrata's (GLEN) recent listing on the Johannesburg Stock Exchange.

IC TIP: Buy at 1275p
Tip style
Speculative
Risk rating
Medium
Timescale
Long Term
Bull points
  • Improved prospects at Minas Rio
  • Rationalisation benefits
  • Glencore listing facilitates potential bid
  • Margins recovering
Bear points
  • Labour problems in South Africa
  • Existing capital commitments

Anglo's share price is off by nearly a third over 2013, and the new chief executive has yet to work through the legacy issues that effectively forced his predecessor Cynthia Carroll to accede to institutional pressure and step down after six years in the job. Ms Carroll had effectively been given a mandate for change at Anglo, but her failure to spin-off underperforming South Africa assets and massive cost overruns at the group’s flagship Minas-Rio iron ore project in Brazil sealed her fate.

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The challenges facing Mr Cutifani were compounded in October when the group revealed disappointing iron ore production figures at the third-quarter mark. However, the improved outlook for iron prices has convinced the new chief executive that Anglo would be well advised to keep full ownership of Minas-Rio. The group had previously taken steps to find a partner in the $8.8bn mine development programme after it was forced to write down its value to the tune of $4bn. But the sheer scale of the expected output from Minas-Rio - 26m tonnes of iron ore pellet feed annually - and modest operating costs of $30/tonne probably convinced Mr Cutifani that the long-term profit potential outweighed the desire to re-coup some of the capital over-runs.

After years of delays and budget blow-outs, first ore from Minas-Rio is scheduled for late 2014. Assuming iron ore prices of $120/tonne (currently $136/tonne), Minas-Rio should generate cash profits of $2.5bn per annum.

ANGLO AMERICAN (AAL)
ORD PRICE:1,339pMARKET VALUE:£17.8bn
TOUCH:1,338.5p-1,339p12M HIGH / LOW:2,089p1,195p
FORWARD DIVIDEND YIELD:4.0%FORWARD PE RATIO:14
NET ASSET VALUE:2,452¢NET DEBT:25%

Year to 31 DecTurnover ($bn)Pre-tax profit ($bn)Earnings per share (¢)Dividend per share (¢)
201028.011.152365.0
201130.611.051074.0
201228.7-0.51-11085.0
2013*30.43.6374.085.0
2014*32.64.8015987.0
% change+7+32+115+2

NMS: 1,000

Matched Bargain Trading

BETA: 1.55

*Deutsche Bank estimates

£1 = $1.64

In line with industry trends, Anglo intends to hive-off non-core assets, while driving operational efficiencies across the group. Mr Cutifani confirmed in December that the new commercial focus is "already delivering enhanced margins". Anglo cautions that the benefits of the changes underway won't become fully obvious until 2015/16, by which time the group is hoping to report a $400m uplift at the operating level. Nevertheless, management has just confirmed that 2014 cash-flows will benefit by around $300m as the group re-jigs its project pipeline, while another $400m will be generated from non-core asset sales.

Though Glencore Xstrata's chief executive, Ivan Glasenberg, has poured cold water on the notion, we think that it is quite conceivable that the Swiss commodities giant could be lining up for a tilt at Anglo. For a start, the Joburg listing enables Glencore to pursue a share-backed offer, instead of a cash bid which would have been the case if it had remained listed offshore - it could also forestall any potential anti-trust issues. And Glencore Xstrata's management might receive an easier ride from South African mining unions, given that, unlike Anglo American, it isn't encumbered with any baggage from the apartheid era. Then there's the strategic fit. Glencore earns just under a third of its pre-tax profits from copper, about 14 per cent from coal and the same from zinc, and another 22 per cent from marketing a variety of metals.

The Swiss group is committed to securing major positions across a broad range of commodities, so the addition of Anglo American's iron ore assets, together with the De Beers diamond business would certainly fit in with Glencore's wider vision. Some might argue that a bid is unlikely simply because too little time has elapsed since the Glencore Xstrata merger itself, but it's also worth mentioning that Xstrata ditched a $30bn bid for Anglo American as recently as 2009.