Friday, October 9, 2015

Anglo American

In general, I hate mining companies. They burn cash when times are good, and they burn cash when times are bad. They always seem to forget that they are in a cyclical industry, so when times are bad they are totally unprepared.

I generally avoid investing in mining companies, but there is an exception to every rule, and my exception is Anglo American (AAL,AAUKY).

Like every other mining company, they are caught with their pants down, having committed capex to open/grow mines that nobody now wants. As a result, the share price has gotten smoked, down about 75% from its five-year high. While that kind of price drop is my kind of thing, it's not enough to make me interested in an industry as horrible as mining. Fixed costs, debt, and throwing risk to the wind during the good times can make a 75% drop justified.

But Anglo has a mining asset that is a little bit unique: it owns De Beers, the diamond company you love to hate. Diamonds are not quite like other mined resources, because it is a bit of an oligopoly. De Beers is no longer the monopoly it once was, but it has enough global market share that it can affect prices by adjusting production, and that's what it does at the margin.

De Beers has an annual EBIT of over $1 billion. The entire company had an "underlying EBIT" of $1.8 billion in the first *half* of this year. Meanwhile, the entire company trades for a market cap of $14 billion, and an enterprise value of $26 billion. The market cap represents a 30-40% discount to tangible book value.

Management is doing what I'd like it to do as well. It is selling the stuff it can't make money from, cutting costs in the ones it can, and reducing its debt levels.

So the company trades at a big discount to tangible book, has a single-digit earnings multiple, and a major portion of its earnings comes from its lucrative diamond franchise. When the mining industry turns around (and it will, because economic incentives currently encourage depletion of mining assets), I would expect a great return from the current price. Not only will earnings rise as prices for commodities rise, but so will multiples as the investing world forgets how risky this industry is.

I got the idea from Victoria-based value investor Tim McElvaine earlier this year. I had been watching it for several months, and finally last week it fell into my sweet spot.

Good luck!


Glenn said...

What would you estimate the NPV to be? I think that would be a better measure of intrinsic value than book value. Given the **massive** drop in iron ore pricing, the current pricing might not be that irrational.

Anonymous said...

I am a bit confused. EV is $1.8B and EV is $24B?