Are Anglo American shares like buying £1 coins for 50p?

Jon Smith takes a look at the falling price of Anglo American shares and asks whether they’re chronically undervalued or it’s a fair drop.

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Last week, Anglo American (LSE:AAL) shares hit fresh 52-week lows at 1,630p. It means that over the past year, the stock has fallen by 47%. This raises an interesting question for value investors. Is the stock trading at almost a 50% discount for the long term, or is this the new normal?

Cuts everywhere

Part of the plunge in the share price last week was due to a disappointing trading update. The business is forecasting a production cut of 4% next year. At the same time, it’s trying to cut costs aggressively in order to “unlock value”.

What this means in terms of numbers is that it plans to reduce costs by $1bn by the end of next year. This includes reducing capital expenditure, reducing employee headcount and other measures.

Considering that the firm posted a profit after tax last year of $9.48bn, if revenue stays the same but costs are reduced by $1bn, it could mean a material boost to the bottom line. This would likely help to push the share price higher.

The price-to-earnings ratio is 5.63. This ranks below my benchmark figure of 10 that I see as fair value. So even if profits for the company stay relatively static, I still believe the share price should be higher than it currently is, to reflect that fair value.

Issues with lower Capex

That said, one reason why the share price might not be good value is the impact of lower capital expenditure. The firm is targeting $1.8bn lower capex in the 2023 to 2026 period.

Of course, this cuts costs in the short term, but hurts in the long term. A lack of expenditure on new projects or renovation of existing ones is a warning sign to me. It could make the firm less competitive and also could limit future revenue opportunities.

This could ultimately limit the growth potential of Anglo American. As a result, investors might have to get used to the current share price, as future expectations are stunted.

A good metals outlook

Given the impact on the business on the price of metals, this is a key factor to consider. The CEO commented that “the fundamental supply and demand picture for many metals and minerals is ever more attractive”.

If we do see an increase in the price of platinum and other metals, I think it makes the current share price look undervalued. The higher base prices would cause revenue for Anglo American to increase, with a larger profit margin.

But I don’t think it’s fair to say that Anglo American shares are trading at a 50% discount to the fair price. The cuts to production and expenditure will dampen potential future growth. But based on the low price-to-earnings ratio, I do believe that the stock is undervalued. On that basis, I think investors should consider adding the stock to a portfolio.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Jon Smith has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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