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Anglo American plc: what to expect in 2017

Anglo American: Fair use

Anglo American (LSE: AAL) was the FTSE 100’s biggest winner in 2016, logging a gain of nearly 300% over the 12-month period.

A repeat performance in 2017 seems unlikely, but the shares still look decent value to me. Although shareholders do face some risks, I think there’s a real chance of further gains over the coming year.

Low costs are king

Mining profits are affected by three main factors. Commodity prices and exchange rates have a big impact, but can’t be controlled by individual companies. However, the third factor — costs — can be controlled.

Anglo’s management expect to have delivered $1.6bn of cost reductions in 2016. The firm’s copper production costs fell by 19%, for example. The combination of higher commodity prices and lower costs should make Anglo a significantly more profitable business in 2017.

Lower costs should also mean that the group can stay profitable at lower commodity prices, reducing the risks faced by shareholders.

Will commodities stay strong in 2017?

Demand for coal and iron ore rose sharply in 2016 as a result of actions taken by the Chinese government. I wouldn’t be surprised if prices pulled back slightly in 2017, but a full-scale slump seems unlikely. For now at least, demand seems stable.

Having said that, there’s no way to know how the Chinese authorities will act as they continue to try and manage the development of their economy. A second unpredictable factor that could influence the prices of Anglo’s commodities is the US President-Elect, Donald Trump.

Mr Trump promised to increase spending on infrastructure during his campaign. This could be positive for commodity prices, but as yet Mr Trump doesn’t seem to have made any firm commitments.

One risk that would affect UK investors in particular would be if the pound was to gain strength against the dollar. This would reduce the value of Anglo’s US dollar earnings when they were converted into pounds.

Anglo still looks cheap

Market conditions look supportive, but the real reason I’m holding to my Anglo American shares is that I still think they look cheap.

My calculations show that Anglo shares currently trade on a multiple of just 4.6 times the firm’s 10-year average earnings. This ratio — known as the PE10 — is a favourite measure of value investors. It highlights companies whose shares look cheap relative to their past earnings.

There’s no guarantee that Anglo’s profits will return to the levels seen over the past 10 years, but history suggests that company performance often returns to average levels over long periods.

The group’s stock also looks cheap based on the latest broker forecasts. Analysts expect Anglo to generate adjusted earnings of $1.90 per share in 2017, 45% more than last year. This gives the stock a 2017 forecast P/E of just 7.7.

That looks cheap to me, especially as the mining industry is only one year into its recovery after a five-year slowdown. If sentiment towards the sector continues to improve this year, Anglo shares could be re-rated onto a significantly higher earnings multiple.

Assuming February’s full-year results don’t contain any bad news, my view is that Anglo remains a buy for the year ahead.

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Roland Head owns shares of Anglo American. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.