After a bruising start to 2016, shares of miner Anglo American (LSE: AAL) were one of the year’s top performers, rising over 250% in value by the end of December. This will be a tough, if not impossible, act to follow in 2017 but at least the company’s Q4 production report showed it’s making solid progress in its effort to increase efficiency, cut debt, and re-focus on core competencies.
Production of the miner’s four most important commodities, as measured by the underlying EBIT they generated in H1, each showed positive production increases year-on-year.
|
|
H1 EBIT |
Q4 y/y production increase |
|
Diamonds |
$585m |
10% |
|
Iron ore |
$390m |
18.3% |
|
Coal |
$160m |
1% |
|
Platinum |
$134m |
2% |
The fact that higher production volumes were achieved despite a slew of divestments speaks well of management’s ability to wring efficiencies out of the core mines even as they slash capex. Likewise, an across the board increase in average realised prices for key commodities from H1 to H2 2016 is great news as the company focuses on cutting debt.
This focus on improving the health of the balance sheet is critical as at the end of H1, net debt of $11.7bn represented a gearing ratio of 35.4%. The good news is that between the end of the H1 reporting period in June and today there have been divestments totalling at least $1.8bn, the vast majority of which will be used to pay down debt.
While it’s looking as if the slimmed-down Anglo American is in better health with debt falling and core low-cost-of-production assets generating impressive cash flow, the ability of shares to continue soaring stays dependent on commodity prices moving up significantly. Although mooted plans for a major American infrastructure investment programme would help, it’s highly unlikely this would compensate for continued slowing growth in China. With Anglo American shares trading above historical valuations, I’d be wary.
Safe haven?
This is the same problem facing its larger rival, Rio Tinto (LSE: RIO). Shares of the Anglo-Australian giant have doubled over the past year as steadily rising iron ore prices coupled with a sensible level of gearing and hefty dividends have made Rio the must-have safe haven stock in the mining sector.
There’s good reason for this as Rio’s iron ore mines are among the best in the business. Production costs at the company’s massive Pilbara mine are low enough that the iron ore division generated $7.8bn in EBITDA in 2015 even as average received iron ore prices fell from $88 per ton to $50 year-on-year.
With iron ore prices now once again above $80 per ton, Rio’s short-term outlook is very bright. Indeed, cash generation in H1 was strong enough that gearing fell to 23% and the board maintained its commitment to a full-year dividend of no less than ¢110. Even better news is that with free cash flow exceeding expectations and new self-imposed caps on dividends, excess capital is likely to be returned to shareholders through share buybacks in the coming quarters.
Rio Tinto shares are very pricey at 17 times forward earnings, which is enough to give me pause despite world-beating assets, a healthier balance sheet than rivals and shareholder returns ramping up significantly.
