WHAT WENT WRONG?
There are several reasons for Anglo’s relative underperformance. Chief among these is the group’s differentiating commodity mix compared to peers – Anglo’s mix is geared more towards platinum group metals (PGMs) and diamonds. These consumer-facing commodities, which made up roughly 40% of Anglo’s profits in 2021/2, corrected significantly over the period as rising interest rates influenced demand, lab-grown diamonds flooded the market and, in the case of PGMs, a large destocking of palladium and rhodium more than offset fundamental deficits.
In addition, many of the group’s operations started underperforming for a variety of reasons, including poor logistics (Kumba), low grade (copper mines, Mogalakwena platinum mine, nickel) and several operational issues at its coking coal mines in Australia. According to Anglo’s annual investor update in December, almost all assets will see their production guidance lowered over the next three to four years. The share price corrected by almost 25% in the days following the update as the average broker cut the group’s near-term earnings by a similar magnitude.
A BROKEN BUSINESS?
While we agree that there were some operational hiccups that could have been avoided, most of the December downgrades came down to proactive asset management in response to either weak markets (diamonds and PGMs), poor performance from Transnet (Kumba) or temporary bad grades (at the Los Bronces copper mine).
Also, despite the downgrades, Anglo still has a strong portfolio of long-life, low-cost assets in commodities that will be needed for decades to come. The average asset in the group’s portfolio has a mine life of more than 30 years and is situated in the bottom half of its industry cost curve.
We’re also seeing increased management focus on unlocking value in the portfolio. In February Anglo announced a strategic partnership with Vale at its Minas Rio asset that will see Vale contributing its adjacent iron ore resources to the Minas Rio mine in exchange for a stake in the combined business.
While the word ‘synergy’ is often bandied about when talking about mergers and acquisitions, in our view, combining adjacent assets is not just hot air, but rather a real synergy opportunity. Among the other options being explored is for Anglo’s large Collahuasi mine in Chile to be combined with the neighbouring mine, Quebrada Blanca. While this is a more complex deal, with six partners, significant value can be added by combining these two assets, so it is in our view well worth pursuing.
Other management initiatives include a company-wide cost optimisation exercise (~5% operating costs targeted), seeking a partner at the group’s large polyhalite (multi-nutrient fertiliser) mine in the UK to realise early value, and conducting a strategic review of all struggling segments (notably nickel, coking coal and diamonds).
Anglo owns 85% of De Beers, and diamonds are the one area of concern for us in the Anglo portfolio, including the structural impact of much cheaper lab-grown stones on the sustainable price for natural diamonds. These products, which now constitute more than 20% of global diamond supply compared to very little just a decade ago, are having an especially large impact on the lower-end (<1 carat) market.
While we do think that the current cycle is close to a bottom and that a lower interest rate environment will support a near-term upcycle, the longer-term case remains uncertain. It is important to put this segment into context though: over the past five years, diamonds contributed less than 10% of Anglo’s profits on average and are valued at less than 15% of the entire group by the average broker in the market. Therefore, while not insignificant, the structural risks to the Anglo portfolio should also not be overplayed.
BRIGHT PROSPECTS
What excites us about the investment case at present is the fact that we still see a robust medium-term upcycle for PGMs, while the prospects for copper just keep getting brighter. Together, these two segments constitute nearly half of Anglo’s normalised profits and the average broker valuation (roughly a quarter each).
While the threat to PGM demand from electric vehicles can’t be ignored (autocatalysts in internal combustion engines make up around two thirds of PGM demand), we still see a strong medium-term cycle for these metals. It is becoming increasingly clear that hybrid vehicles, which still use autocatalysts, will play a much bigger role for at least the rest of this decade, leading to demand being more resilient than currently factored in by the market.
In addition, mine supply, especially from South Africa, will be severely constrained – at current prices, half of the industry either makes no money or is suffering losses, which is clearly unsustainable. This has already led to large cuts in future replacement and growth projects. If prices remain low for longer, this will lead to more extensive supply cuts at existing mines. Anglo’s PGM mines are also of a higher average quality than the rest of the industry and are thus in a better position to withstand lower prices for longer if needs be.
Copper is still the commodity that excites us the most in the Anglo portfolio. Demand from the energy transition is gaining momentum while mine supply is particularly constrained as grades decline in ageing ore bodies. The market had previously been preoccupied with near-term surpluses (before we enter a period of sustained deficits later in the decade) but even these have now all but vanished on supply disappointments.
While current prices of just above US$9 000/t are at a healthy level, they may not be high enough to incentivise sufficient new projects to come online to meet the required demand. This is a great outcome for companies with long-life producing copper assets like Anglo American.
WHERE COULD WE BE WRONG?
No investment case is without risks – lower commodity prices being the most important risk for a mining company. Steelmaking ingredients iron ore and coking coal (which constituted about half of profits in 2023) have held up relatively well over the past few years but are now starting to correct on weaker Chinese steel production. Should we see these prices come off meaningfully while PGM and diamond prices also remain weak, further downside in earnings and the Anglo share price will likely follow. Other risks include further operational disappointments. However, we do feel that the likelihood of these has diminished significantly following the large downgrades in December.
