The following updated Morningstar analyst report examines prospects for Anglo American (AAL). Analyst Daniel Rohr also explains the reasoning behind his downgrade to the company’s shares, estimating the miner’s fair value rests at 2,200p per share.
Anglo American: Current Operations and Future Projections
For the past decade, emerging-market growth--and the commodity demand that accompanies it--has pushed commodity prices to record highs and the profits of miners such as Anglo American (AAL) to previously unheard-of levels. In the decades to come, no single factor will play a more important role in Anglo's future than the economic trajectory of emerging markets, particularly China.
While all miners are, for better or worse, hitching a ride on the Chinese economy, Anglo's exposure to the China story is somewhat atypical. Compared with most peers, Anglo's portfolio has less exposure to commodities like iron ore and metallurgical coal that are critical to the investment-heavy early stage of economic development. Anglo has greater exposure to late-stage commodities like platinum and diamonds, which benefit most as increasingly well-to-do consumers look to enjoy the fruits of their labour. To the extent we see Chinese growth transition from the investment-led story of the past decade to a consumption-led future, Anglo is arguably better positioned to benefit than most diversified peers.
This is not to say Anglo's exposure to the investment side of China's development is immaterial. Iron ore, the physical bones of fixed-asset investment, ranks as Anglo's largest segment in revenue terms at $8.1 billion in 2011, 22% of consolidated revenue. The business produced 46 million tons in 2011, mostly in South Africa. Output is set to increase markedly as key growth projects come to fruition, headlined by the long-delayed Minas-Rio project in Brazil, which would add 26.5 million tons per annum. Combined with the Kolomela project in South Africa (9 Mtpa), we expect production to exceed 80 Mtpa within the next few years. While far from the largest player in the seaborne iron ore game (even after Minas-Rio and Kolomela), Anglo is a low-cost producer, a fact which should keep the business solidly in the black even if, as we expect, iron ore prices fade considerably from the record $169 per ton averaged in 2011.
Platinum, used principally in consumption goods like autos and jewellery, is Anglo's second-largest segment by revenue at $7.4 billion in 2011, 20% of the total. Here, Anglo ranks as a global titan with about 40% of global output. Despite its unparalleled size, the business punches below its weight from a profitability perspective, contributing a modest 8% to Anglo's total operating profits in 2011. Given the sheer size of the business, operational improvements would have major implications for overall earnings, which is why this has been an area of strategic focus for management. Thus far, results have been mixed and we expect persistent upward pressure on wages and electricity, plus the continued progression into less favourable geology in the coming years, will limit the benefits Anglo hopes to achieve.
Anglo's diamond exposure, the largest of its peer group, comes from a 45% stake in De Beers, the world's leading diamond producer. While Anglo's proportionate share of revenue accounted for a modest 9% of total 2011 revenue, the contribution is set to increase greatly pending the $5.1 billion acquisition of an additional 40% stake from the Oppenheimer family. On a pro forma basis, the deal would make diamonds Anglo's third-largest business, amplifying the firm's exposure to the consumption side of emerging-market growth.
Valuation, Growth and Profitability
We're lowering our fair value estimate for Anglo American's London-listed common stock to GBX 2,200 from GBX 2,600. The 15% reduction is principally attributable to higher cost assumptions in the company's metallurgical coal, thermal coal, and iron ore businesses.
Anglo's production growth in the next few years will come in the form of three major projects: Los Bronces in copper (about a 45% increase to consolidated copper volume), Minas-Rio in iron ore (about a 60% volume increase), and Barro Alto in nickel (about a 200% volume increase). We expect profits to contract in 2012 largely on the back of broadly weaker commodity prices, offset by volume growth in many segments.
We now assign a high uncertainty rating to our fair value estimate. While we recognize the substantial uncertainty surrounding Anglo's future operating profits (mostly due to commodity price risk), we think a rating of high better captures the offset afforded by the company's modest balance sheet leverage than did our previous very high rating.
Commodity price assumptions are the primary drivers of our valuation of Anglo. Our fair value estimate of GBX 2,200 per share incorporates the following key mid-cycle commodity price assumptions: copper at $2.50 per pound, platinum at $1,700 per ounce, thermal coal at $100 per ton, metallurgical coal at $200 per ton, and iron ore at $90 per ton (CFR China).
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