Why Anglo American represents a better investment than BHP Billiton?

Dr Adrian Saville, CIO of Cannon Asset Managers, has a look at the metrics of these diversified resources companies and concludes that Anglos offers better value than BHP Billiton

Better commodity prices have sparked a renewed interest in resource stocks and we have been asked which of Anglo American Ltd (Anglos) and BHP Billiton Ltd (Billiton) we would buy. At Cannon Asset Managers we seek out companies which offer deep value, quality and have better-than-market prospects as an investment.

Of the three factors – value, quality and prospects – we consider the first to be a pre-condition for making an investment in a business. Whilst establishing value varies by company, industry and market, there is a set of metrics that are common to identifying value across companies. In this regard, and as value mangers, it will come as no surprise that we favour investing in companies that return profit to us in the form of dividends. On this score, it is our view that, after suspending its dividend last year, for the first time in seventy years, Anglos will resume dividend payments this year. We think that it is reasonable to assume that Anglo’s earnings will cover the resumed dividend three times. This places the company on a prospective dividend yield of nearly 4%(and maybe more).

If this view is correct, then Anglos is trading on a forward dividend yield that is twice the current market yield. This yield also compares favourably to the Billiton prospective yield of 2.8% which, while better than the market, is well below our expectations for Anglos.

On a price:book ratio basis, Billiton is trading at 3.5 times, while Anglos is priced at 1.7 times. While price:book is not the most obvious metric for valuing a resource business, it often serves as a helpful guide to identifying value. On this basis, Anglos looks comfortably more attractive than Billiton. Anglos’ price:book is below its long-term average, below the theoretical average we estimate to represent fair value (2.5 times) and well below Billiton’s multiple.

Considering earnings, both of the counters look appealing using a conventional price:earnings multiple. At current prices, there is little between the two in terms of the rating being applied to trailing earnings. Given the superior quality of Billiton’s management (and arguably its assets) this suggests Billiton is a better decision. However, the cyclicality of commodity company earnings needs to be taken into account. On this basis, the forward price-earnings multiple of Anglos at around 7.5 times is some 25% lower (cheaper) than Billiton which is just shy of 10 times.

However, extending this principle to through-the-cycle earnings arguably provides greater clarity on the value resident in Anglos.The table below shows the price:earnings on the general miners and related commodity companies (oil, diamonds) in our universe.One should bear in mind that a normalised price:earnings ratio of less than 16 is needed to identify a company as ‘cheap’.Using this metric, Anglos, Merafe Resources and Sasol stand out as attractive.Further, Anglos stands out as specifically cheap relative to Billiton and other largergeneral miners, such as African Rainbow Minerals and Kumba Iron Ore).

It may be claimed that Billiton is a better business, with its high quality management and stronger balance sheet, not to mention its mining assets, and we do not disagree with this perspective. But, our view is that this is built into the Billiton share price. Anglos, by contrast, is cheap relative to its history, the assets it owns and what management is capable of doing with these assets. Moreover, our research suggests that recent events at Anglos will lead to a higher quality business and this view is supported by recent evidence that points to improving quality at Anglos. Put together, these factors of value and improving quality lead us to conclude that, of the two businesses, Anglos has greater investment merit.