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Anglo American share price weakness may create opening

In depth
This article is part of the dossier: Investing for income

By David Whitehouse
Posted on Wednesday, 25 September 2019 12:00

Mark Cutifani, CEO of Anglo American, has been trying to turn the mining company around. REUTERS/Mark Wessels/

Income investors are “generally not accepting “of large fluctuations in returns, says Izak van Nierkerk, an investment analyst with Mergence Investment Managers in Cape Town.

Van Nierkerk points to falling commodity prices in late 2015 and early 2016 which led to mining companies having to cut their dividends.

But in a world of negative developed government bond yields – meaning that pension funds pay for the privilege of handing your money to a developed country government – that tolerance of volatility may have to increase.

The first in our series of articles on investing for income in Africa in a world of low and negative interest rates focused on Grit Real Estate.

  • This week we turn to a mining stock big enough to attract investors who would normally avoid the continent: Anglo American.

Over the last five years, Anglo American has achieved a transformation from “a sprawling conglomerate of poorly connected operations” into a “dynamic mining company with a leaner set of assets, clear sense of strategy, and efficient transfer of technology and expertise among divisions”, according to analysts at Société Générale wrote in March.

The bank, though, saw Anglo American shares, which were then trading at 2,018p in London, as no more than a “hold”.

There were, the Société Générale analysts wrote, few catalysts to push the stock higher in the short term.

  • Favourable sentiment towards the mining sector was as a result of optimism of a quick resolution to the US-China trade dispute – optimism that has proved to be unfounded.
  • Since March, Anglo American shares have lost about 10% of their value and now trade at 1,823p in London.
  • As the shares fell, Société Générale in May upgraded its recommendation to “buy”.
  • The shares now offer a dividend yield of 4.95%.
  • Shareholder returns will be further enhanced by a share buyback programme announced in July of up to $1 bn.

Van Nierkerk at Mergence says that the company’s policy of paying out 40% of underlying earnings is “prudent” as dividend and buyback returns depend on fluctuations in commodity prices.

  • High iron ore prices made the $1bn buyback possible, he says – but there is no guarantee that such prices will continue.
  • As Société Générale argues, there is no guarantee that a resolution of the US-China trade war would lead to an acceleration in Chinese growth – a key driver of commodities prices.

Leverage constraint

A key constraint to higher dividends, Société Générale wrote in March, is the leverage in the group’s assets outside South Africa.

The ratio of non-South African net debt to earnings before interest, taxes, depreciation and amortization (Ebitda) stood at 1.5 times at the end of 2018, versus 1.3 times for South African debt.

  • Société Générale argued that it would take one to two years for non-South African leverage to stabilise below 1.5 times, and so predicted that Anglo American’s dividends would converge with free cash flow (FCF) by 2020 or 2021.
  • That creates the prospects of a powerful upward momentum in dividends: Société’s Générale’s forecasts were for free cash flow yields of 6.2% and 6.1% in 2020 and 2021.
  • By the end of 2024, the research predicts, free cash flow is likely to approach 10%, driven by lower levels of required capital expenditure and earnings growth.

Whether the volatility that is likely along the way is tolerable will be dictated by the amount of diversification with an income investor’s portfolio. These articles are not intended as investment office and readers should do their own research and/or take professional advice before investing.

Bottom Line: With the realistic prospect of a protracted trade war now priced in, Anglo American shares are likely to offer value for diversified income investors over the medium term.

 

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