Anglo American cuts production, but now's not the time to sell

Disclosure: I own shares in Anglo American.

It’s clear that my Anglo American buy in the summer was far too early. I hadn’t foreseen the scale of the commodity slump that’s played out since then.

In July, I was reassured by Anglo’s interim results, which didn’t seem too bad. Cash generation was strong and the firm seemed to be holding it’s own in terms of meeting profit forecasts.

Since then, the firm has completed the sale of the Norte copper business, adding $1.3bn in cash proceeds to the $300m received earlier this year from the sale of the Lafarge Tarmac business. Yet this might not be enough.

Yesterday’s production update showed a dramatic 27% slump in diamond output as the firm cuts volumes in the face of weak demand. DeBeers, in which Anglo has an 85% stake, generated 30% of the firm’s underlying operating profit during the first half of ths year…

Dividend and debt

The elephant in the room is Anglo’s $11.9bn net debt. A report from JPMorgan Cazenove quoted in the FT recently suggests that Anglo needs to raise another $2.5bn or so in order to protect its investment-grade credit rating.

Scrapping the final dividend seems increasingly likely to me. The current forecast yield of 7.8% is a clear warning that the market expects a cut. However, forgoing the final payout would only save around $400m.

The only way that the firm can raise the kind of money suggested by JPMorgan is through further assets sales or by issuing new shares.

My feeling is that this risk may already be reflected in Anglo’s share price. Glencore and Lonmin — two more severely afflicted companies — have both bounced recently after announcing a placing and rights issue respectively.

Anglo hasn’t yet issued a formal profit warning since its interim results. This suggests to me that at the moment, consensus forecasts for earnings of $0.91 per share this year remain broadly valid.

It’s worth remembering that while earnings might be weak during the second half, further cost cuts are expected to take effect too. These two factors may largely offset each other.

On that basis the shares now trade on 10 times forecast earnings. Regardless of the near-term dividend outlook, that doesn’t seem outrageously expensive unless you think the business is fundamentally unsound. I don’t.

I’m not in denial. Things really could get worse at Anglo American.

Despite this risk, I’d be happy to average down at sub-600p. Following my latest buy, however I am too fully invested to do so without selling elsewhere. So in the absence of any new information, I will do nothing.

Disclaimer: This article is provided for information only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.