Core Business Fundamentals
You can read my take on the Mining sector in my recent post on VALE.
Anglo American (AAUK) is amongst the largest mining and natural resource groups in the world. I like because of my expectation of strength for the sector, I like it for its asset portfolio and most importantly, I like the management.
AAUK has a strong asset portfolio including copper, iron ore, coal, platinum and diamonds. Their assets are long life, with an average project life of 40 years compared with an industry average of closer to 20 years. Their assets are below median on the cost curve; this means that they will benefit during expansions from higher prices as a result of high marginal cost of production. It also means that during contractions, production cuts from higher marginal cost producers will come ahead of AAUK cuts. AAUK also holds leading positions in platinum and diamonds. The scope for growth is immense; the approved project pipeline is $16 billion with huge growth opportunities beyond the approved pipeline.
- In iron ore Minas-Rio is a top quality opportunity; this is a world class opportunity – the mine has high quality iron ore with a Fe content of 68% (even ahead of typical Brazil Fe content which is so popular in China); total resources are estimated at 3.9 billion tons; first production should start by Q2 2012 at 26.5 mtpa and there is scope to expand this to 80 mpta.
- In copper targeted acquisitions such as Michiquillay and Pebble are both great opportunities which will enhance AAUK’s strong position in that market. The Los Bronces asset is the world’s 6th largest copper mine (173,000 tpa) with first production planned for 2011; it is amongst the lowest cost mines in the world with cash costs of $0.69/lb.
- In Nickel, Barro Alto is a large scale, low cost (second quartile - $3.2/lb cash cost), long life project. Production of 36,000 tpa is targeted by 2011; at full production in 2012, AAUK’s Ni production will double.
- Finally, the AAUK stake in platinum has been increased to 80%.
I like the management for its swift, decisive and firm response to the crisis. The immediate response was highly focused, capex plans were sliced in half to $4.5 billion; platinum output was sliced; diamond production was cut by as much as 40%. Met coal production growth was abruptly halted.
The next actions might have been unpopular with shareholders, but they were certainly in the best interest of the company; and ultimately it will be in the best interests of shareholders. Like a firm parent, they took away the child’s lollipop and cut the dividend; this saved $1.6 billion per annum. Frankly, the action was both required and desirable; it had to be done to protect long term interests of all stakeholders, including shareholders. The AGA divestment raised another $1.8 billion. $2 billion was raised through a bond issue in April 2009 and another $1.7 billion was raised through a convertible bond issue. One major task ahead of leveraged companies was to rapidly repair balance sheets to weather the gathering storm. AAUK is now in a position, where no further financing will be required during the medium term; they are well positioned to weather the crisis.
They have also made and delivered on other hard decisions; at Anglo Platinum (OTCPK:AGPPY) a reduction of 10,000 heads was targeted, 40% is complete by end of Q1 2009. Output at higher marginal cost mines has been cut, while maintaining production at assets at the lower end of the cost spectrum; Mogalakwena & Bleskop have seen a 50% reduction in output. Operating cost cuts have been targeted and costs are down 7% in real terms. Efficiency has been improved with tonnage per employee rising by 26%.
In diamonds, similar action has been taken; cost reduction of operating expenses versus 2008 of 47% are targeted; capex has been cut by 70% compared to 2008; head count will see reductions of 1,800 and production has been cut by 40% for 2009.
All this has been achieved with what is likely the most robust growth pipeline of $50 billion remaining intact.
- In 2010/2011, the pipeline is expected to deliver first production at Los Bronces in Cu and Barra Alto in Ni; both are large opportunities. There is also Twickenham for platinum which is a mid size opportunity. Then there are smaller opportunities in Cu at Collahuasi (expansion) and at Elders (underground and open cast) for thermal coal.
- In 2012 to 2013, iron ore will see the large Minas Rio phase one come on line; at the same time the mid size Sishen South and Sishen Expansion projects will commence production. For Platinum, the large scale Amandelbult will commence production. The large scale New Largo thermal coal project comes on line. Smaller projects (Cerrejón and Heidelberg underground) also deliver first production during this period.
- Looking out to 2014 and beyond; unrivalled Cu opportunities on a massive scale can be looked forward to via Quellaveco, Michiquillay and Pebble. Jacaré is a large scale Ni opportunity which is also an unrivalled opportunity. And finally a smaller opportunity via Sishen pellets.
At the end of 2008, AAUK had shareholders equity of $20,221 million. Its long term debt stood at $7,272 million, short term debt stood at $6,784 million. Cash and short term investments were $3,316 million. Long term financial investments were $3,119 million. Net debt was thus $7,621 million; 27% of net debt plus equity. In my view this is not over-leveraged. Yet the company responded to the crisis strongly because the extent and duration was not predictable; in addition the debt profile meant that liquidity was needed to pay down short term debt. It is fairly clear that with the actions taken, no additional financing will be required in the short term.
In a sense, the widespread fear of debt and deflation created some amazing opportunities amongst leveraged companies. Risk taking investors could benefit from chronic undervaluation in levered companies with strong asset backing; this opportunity was seen at AAUK, MT and RTP. All of these companies were able to quickly move to repair what was seen as damaged balance sheets; and all of these companies might benefit in future inflationary periods as debt loses value in real terms.
Delivering and Returning Shareholder Value
During the period from 2001 to 2008, AAUK returned shareholder value through a dividend payout ratio which ran at a median of 44%. A final dividend was not paid for 2008; I do not see the dividend cut as disturbing the long term trend of dividend growth. Dilution has been well managed by buybacks; but unfortunately the significant buybacks occurred during 2007, a period when share prices were nearing a cyclical peak. You can view my take on share buybacks and dividends as being important means of returning shareholder value in a prior post.
Between 2001 and 2008, EPS grew at an annualized rate of over 18%; average annual share prices rose by 20.78% annualized. With 2009 EPS expected to fall to $0.81, EPS will have fallen at an annualized rate of 4.4% since 2001 when EPS stood at $1.22; this is why I feel consensus EPS is probably lower than what will occur which makes a case for earnings surprises to the upside. The average share price year to date 2009 is $11.13 compared with $5.41 during 2001; which means the annualized return is over 8.3%. This on top of a total dividend of $7.23 collected over the years.
Overall, this is a satisfactory performance for long term investors.
Can these growth rates be maintained? I believe AAUK is likely to maintain a higher growth rate as a result of its quality portfolio. I also believe AAUK is an attractive acquisition target for this very reason. On balance, I believe a very significant premium will need to be paid for an acquisition or merger to make sense; otherwise AAUK will outperform on a stand-alone basis. As a result of the crisis related uncertainty I will use a long term EPS growth rate of 7% (global GDP long term growth rates plus inflation; 3.5% each) in valuing the business.
Using the adjusted Gordon’s Growth Model, I would look for 40% payout of the six year average EPS of $2.94; that is $1.18. Assuming 7% growth on this expected payout and a 15% investor return expectation, I would value AAUK at $15.72 for a long term investor. Book value per share should provide support at this level; book value excluding goodwill is $12.62, a level where I expect support to hold. This share trades at low valuations because it has not captured investor interest; it has also lost wide investor interest as a result of the dividend cut. For investors with a shorter term horizon, an appropriate exit price might be the median PE 6 (the price divided by 6 year average EPS) multiplied by 6 year average EPS of $26.
I believe the share is undervalued and trades at a deep discount to its intrinsic value. Peak earnings were at $4.7 during 2008, next peak earnings including the $16 billion approved project pipeline should be at least $6.5; valuing the share at 5X peak earnings would give an achievable exit of $32.50; taking the multiple to 8X would give a $52 price objective which could be an aggressive estimation of next peak value at this point in time.
Disclosure: Long AAUK, MT, RTP