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Anglo American: Slimming down for the summer

08 March 2016 Shiraaz Abdullah, Sanlam Private Wealth
Shiraaz Abdullah, Investment Analyst at Sanlam Private Wealth.

Shiraaz Abdullah, Investment Analyst at Sanlam Private Wealth.

Anglo American announced a major shift in focus at its recent full-year results presentation. The company is reducing its portfolio of assets to produce three products – platinum, diamonds and copper.

Anglo has competitive advantages in these three resources through scale as well as the quality of its assets. We’re pleased with the steps the company is taking as they mirror our reasoning for holding the company in our portfolios. We placed the most value on these assets and believed the market did not give the company full credit for them, as the focus last year was on decreasing prices of China-related commodities and the state of the balance sheet.

Anglo American is able to influence supply, and hence prices, in both diamonds and platinum due to its relative size in the industry. In copper it does not have this luxury as the market is a lot more fragmented, but Anglo has some comfort from its cost positioning relative to other market participants. From a demand perspective, the company will be reliant on consumers in a variety of geographies as opposed to infrastructure spend in China.

The changes will be facilitated by divestments in commodities it deems non-core, in other words, coal, nickel, niobium, phosphates and iron ore. It will use the proceeds of these divestments to pay down debt and as a result bring down the company’s overall risk. The company has targeted between US$3bn and US$4bn in divestments for 2016. This will largely alleviate concerns around its debt levels and allow the market to refocus on these assets’ ability to generate cash.

One of the most important aspects of this change is that it will allow the company to better navigate a further downturn in commodity prices.

There is a concern that Anglo American is selling assets at the bottom of the cycle, which is a valid point. However, one must weigh this up against the alternative, which is the overstretched balance sheet due to prior capital misallocation. The current management team can only play the hand it is dealt.

We believe shoring up the balance sheet is key to enabling the business to operate in any price environment. We are averse to losing good assets below our deemed fair value, but good assets are not where the largest value leakage occurs. It is in the marginal assets, which are worth very little in a downturn and sold for way too much in an upturn. Being on the wrong side of this is where value is permanently destroyed.

Looking at the deal for the Rustenburg platinum assets, we can see management is aware of these concerns and has built in a clause that allows the company to benefit from an upturn in commodity prices. Thus we expect further deals will be structured in a similar manner.

It is near impossible to identify the factor that will change the perception towards Anglo American. It could be earnings release, sale of a specific asset or merely a shift in sentiment, which we believe caused the share to rise so prodigiously this year. In our interactions, it seems like sentiment has changed from ‘potential bankruptcy’ to ‘going concern’. Considering various scenarios for a company is an enjoyable process. However, for this process to add value to an investment it is necessary to focus on the most probable scenarios and weight them accordingly. Thus bankruptcy was never a focus for us, given that the work released by various banks under that guise was largely a static analysis.

Static analysis fails to consider industries as a collection of various companies; some better than others. In mining, a company’s position on the cost curve largely determines how good or bad it is. Thus companies that haemorrhage cash at the top end of the cost curve are most likely to leave the industry first, thereby altering the demand-supply dynamic and consequently shifting prices of products. Assuming these products are not in a structural decline, for example, typewriters, the price should recover and the companies that survive should reap the benefits of having more concentrated exposure. I may be vilified for stating the obvious and preaching entry-level economics, but one look at the volatility of the Anglo share price tells us markets often forget the obvious.

We maintain our holding in the share and are more confident in our investment case post the restructure.

 

 

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