We are cutting our fair value estimate for Anglo American (AAL) to £3.80 from £5 following Anglo American’s Investor Day due to a weaker outlook for the company’s diamond segment. Anglo's high financial leverage, $12 billion of net debt as of June 2015, magnifies the impact of diminished diamond segment profit expectations on our equity fair value estimate.
Persistent commodity price declines have pushed many assets into loss-making territory
The headwinds facing the diamond business appear to be stiffer than we had previously expected. After growing 3% in 2014, the global diamond wholesale market should fall 1% to 2% in 2015 with further weakness into 2016 likely.
Lower polished diamond demand and prices have hurt profitability among De Beers' sight-holder customers, who have accumulated inventories they have difficulty selling. This has pushed down rough diamond prices 15% year to date. In order to keep up pace with the market softness, Anglo expects to cut production by 7% to 26 to 28 million carats in 2016. Most of the cuts will come from higher-cost mines, which should help on the margin front.
Even after the market works through the excess inventories, the magnitude of the market decline suggests that it will be difficult for De Beers to reach the level of profitability that we had previously expected. We've moderated our long-term expectations for the segment's growth and profitability. While we had previously expected the segment to recapture profitability enjoyed in 2014, earnings before tax of $1.8 billion, as the diamond market recovered, we now believe $1.4 billion is a more likely reflection of the segment's mid-cycle earnings power.
Amid persistent commodity price declines that have pushed many assets into loss-making territory, Anglo announced further plans to cut costs and capital expenditures across its portfolio. Anglo also intends to dispose of many of the higher-cost assets in coal, niobium, and phosphates. Anglo has suspended its dividend through 2016. We believe this is the right move, given our forecast for sustained low commodity prices.
Anglo also expects a slower ramp up of Minas-Rio, as it is likely to encounter licensing constraints in Brazil following the Samarco incident. Weak iron ore prices have also led the company to slash growth plans at Sishen in South Africa.