In the face of fearful investor sentiment and strong doubts about Anglo’s ability to generate a future earnings stream, we argued in December for maintaining our holding in the share. It takes much conviction from asset managers to ignore the comfort of a trend, but we stuck with our long-term, pragmatic investment philosophy and continued to focus on the balance of probabilities – the most likely scenario for Anglo American in a highly cyclical sector.
We strongly believed Anglo’s woes wouldn’t continue for too much longer, as this would be unsustainable for the mining sector as a whole. The industry itself was not in structural decline, and Anglo wasn’t the weakest player in the market. In our view, prices would recover over time and the surviving companies – such as Anglo – would be able to reap the benefits of having more concentrated exposure. This is, of course, basic economics, but markets sometimes tend to forget the obvious.
Our confidence in the world’s largest producer of platinum was also buoyed by the group’s management, which in December announced a radical restructuring plan to focus on the production of only three core products: platinum, diamonds and copper. The group said it would divest itself of commodities it deemed non-core: coal, nickel, niobium, phosphates and iron ore – the proceeds of which would be used to pay down debt. We were pleased by this announcement, as it mirrored our reasoning for holding Anglo in our portfolios – we placed the most value on the same three core assets. In fact, we increased our holding in the share for our clients in the period after this strategic decision.
Fast-forward six months to July this year, when the group’s interim results were released. CEO Mark Cutifani announced a much-strengthened balance sheet, and debt reduction of around US$1.2 billion to US$11.7 billion, resulting mainly from cost cutting. He said Anglo would meet its target of cutting debt to below US$10 billion by the end of 2016, to reassure investors it could better navigate any further downturns in commodity prices. Over the period under review, Anglo’s share price rebounded markedly, more than doubling in value.
In our view, Anglo American is now well on track to delivering what the group promised shareholders in December. Underlying earnings for the six months through June fell to US$698 million from US$904 million, importantly beating analysts’ expectations. Anglo is now generating a healthy cash flow, allowing the group to pay down its debt and resulting in much-improved fundamentals. Other than an error in the copper division, to which management admitted, operational performance continues to improve.
Of course, a major tailwind for Anglo over the past six months has been the rebound of commodity prices, especially iron ore and thermal coal. One could therefore ask whether it remains prudent to be divesting the group of these assets? We believe the answer is still yes – but at the right price.
One area of concern is that Anglo’s current management has set a target of achieving a 15% return on capital employed, and we believe there is still much work to be done if this target is to be met. However, if the group continues its cost-cutting drive, it may yet be achieved.
In general, we believe Anglo American has done the hard yards to transform the group over the long term, and we remain confident in our investment case.
