Category Archives: Mining

A tunnel in a deep mine

Is the Anglo American rebound too good to be true?

A tunnel in a deep mineDisclosure: I own shares of Anglo American.

My original investment in Anglo American was far too early. My second purchase — at 369p — was a better effort, although still some way off the bottom.

By early January, things were looking pretty grim. I didn’t have enough cash in my portfolio to average down again so sat tight and endured the 215p low. What I didn’t expect was for such a rapid rebound to follow.

Anglo shares are now up by 77% so far this year. Today’s closing price of 533p means that the loss on my overall position has been reduced from more than 50% in January to just 14%.

To be honest, I’m a bit worried. There has been some good news — which I’ll review in a moment — but is this rally really sustainable? Anglo now trades on 17 times 2017 forecast earnings, despite offering no dividend. The group still faces a challenging set of asset disposals. I mean, buyers are not exactly fighting for the chance to buy coal and iron ore mines, are they?

Having said that, the first two months of 2016 have delivered some good news:

  • Diamond sales are improving: The DeBeers business was one of Anglo’s top profit generators in 2014. The downturn in this business last year was painful and prompted quite rapid action by the firm. This now seems to be paying off. In a new spirit of transparency, Anglo has started publishing sales totals from DeBeers sightholder sales. The last sale (of 10) in 2015 generated sales of $248m. So far in 2016 there have been two sales, which have generated $545m and $610m.
  • Action on debt: Anglo’s decision to use some of its $14.8bn of liquidity to buy back $1.3bn of its own bonds at a discount to their face value was well received by the market. Anglo is planning to reduce net debt from $12.9bn to about $10bn by the end of 2016. The bonds being bought back all mature in 2016, 2017 or 2018. Reducing short-term debt will push out Anglo’s debt maturity profile, improving near-term cash flow and strengthening the balance sheet.
  • Platinum & Copper: the spot price of platinum has risen by 5% so far this year to $944/oz. It’s well off the January lows of $811/oz. A weaker dollar is also helping many emerging market miners. Copper prices are also substantially higher.
  • Restructuring Anglo: Focusing on Anglo’s three strongest commodities — platinum, diamonds and copper — makes sense. Disposing of the firm’s second-tier assets will improve profit margins, cash flow and resilience to future downturns. Along with the debt buyback, this plan will also make the group a more attractive buyout target — something some analysts believe is at the heart of Mark Cutifani’s plans for the firm.

I’m reasonably confident that Anglo’s turnaround plan will bear fruit. However, it’s not yet clear (to me, anyway) how much money Anglo can reasonably expect to raise from its disposals. This will impact on the ability of the firm to reduce debt.

I intend to hold for the time being, although I wouldn’t be surprised to see a pullback of some kind over the next few months.

Disclaimer: This article represents the author’s personal opinion only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.

A tunnel in a deep mine

Is Lonmin becoming a contrarian buy?

A tunnel in a deep mineDisclosure: At the time of writing,I do not own shares in Lonmin.

So the dust has settled and Lonmin shares now trade at just over half their theoretical ex-rights value of 1.2p, or 120p after taking into account this week’s 100:1 share consolidation.

I promised to take another look at the stock after the rights issue was completed, so here goes.

Book value trap

It’s tempting to say that because Lonmin now trades on a price/book ratio of about 0.2 and has very little debt, it must be a bargain.

The problem is that the book value of the firm’s mines and platinum reserves is dependent on their commercial viability. If Lonmin can’t find a way of making money from its mines (or persuade someone else to buy them) then they are potentially worthless.

Thus the firm’s massive discount to book value, while relevant, is not a standalone reason to invest, in my opinion.

What I’ve done instead is to consider what’s changed since the last time Lonmin reported a profit, which was in 2013. In that year the firm reported a post-tax profit of $166m. At today’s share price, this would equate to a P/E of 1.2! I’d argue that a sustainable profit of even one-tenth this amount would be enough to justify the current share price.

Can Lonmin make a profit again?

Leaving aside the strike-related disruption Lonmin has experienced since 2013, there are three main variables which govern the firm’s profitability (or that of any mining firm, come to that):

  • Foreign exchange rates — commodities are generally sold in USD but production costs are paid in local currencies, in this case ZAR (South African Rand);
  • Commodity prices — the price of platinum group metals;
  • Operating costs, principally labour and energy. Labour costs are paid in local currency, but energy may be either or a mixture. For the purposes of this discussion, I’ve included factors such as ore grades within operating costs — after all, the cost of producing metal tends to rise and fall with ore grades.

Currency effects

Emerging market currencies have tended to weaken against the US dollar over the last few years. The South African rand is no exception and the exchange rate has changed significantly (figures taken from Lonmin’s reported full-year averages for y/e 30 September):

  • 2013: ZAR/USD = 9.24:1
  • 2014: ZAR/USD = 10.55:1
  • 2015: ZAR/USD = 12.0:1
  • Today: ZAR/USD is currently c.15:1

In other words, $1,000 of platinum sales in 2013 generated ZAR9,240.

Today, it would only require $616 of platinum to generate revenue of ZAR9,240.

Platinum price

Platinum isn’t mined in isolation — miners such as Lonmin typically produce platinum group metals (PGM). These are platinum, palladium and rhodium. Lonmin typically focuses on the PGM basket price in its reporting, rather than simply the price of platinum.

Here’s how the PGM basket price has changed over the last three years:

  • 2013: $1,100/oz
  • 2014: $1,013/oz
  • 2015: $849/oz

However, when the effect of the ZAR/USD exchange rate is included, the average PGM basket price has remained much more stable:

  • 2013: ZAR10,614/oz
  • 2014: ZAR10,687/oz
  • 2015: ZAR10,188/oz

The improving exchange rate wasn’t enough to offset falling PGM prices in 2015. But whereas the USD PGM basket price fell by 16% in 2015, the ZAR value of the PGM basket only fell by 5%.

But here’s the interesting bit…

In late December 2015, the USD prices of platinum and palladium are about 20% lower than the averages reported by Lonmin for last year. If we assume that the group is working with a PGM basket value around 20% lower than last year, this works out at about $680/PGM oz.

However, the exchange rate has also changed. As I write, the rate is about 15.1:1. This gives a PGM basket price of about ZAR10,200. In other words, exactly the same as last year.

What about costs?

The final factor in our trio of variables is costs. Lonmin’s old, deep platinum mines are notoriously labour-intensive and costly (and dangerous) to mine. As a result of the industrial unrest over the last couple of years, Lonmin has, like most other South African deep miners, increased pay rates for mine workers. (Deservedly, in my view).

However, the firm has also reduced the workforce and announced plans to shut various shafts to focus production on the lowest-cost areas of its mines.

The most sensible way of viewing costs is probably to consider Lonmin’s reported production costs for the 2015 financial year, which were ZAR10,339 per PGM ounce. At the current exchange rate, that’s $684 per PGM ounce.

This suggests to me that the price of PGM metals would only have to improve by a small amount to enable Lonmin to breakeven at an operating cash flow level.

Unit costs are expected to be relatively flat at c.ZAR10,400 until 2018. However, the firm also that it is targeting workforce and overhead reductions of ZAR700m in 2016 and of ZAR1,600m in 2017, which could help achieve breakeven.

What could go wrong?

This article is getting quite long, so I’ve condensed this section into a list. These are all known unknowns, in my view — risks that investors have little way of quantifying:

  • The exchange rate could move against Lonmin
  • Further industrial unrest
  • What is the state of global PGM stockpiles?
  • How healthy is platinum/PGM demand?
  • How will PGM prices move from here?

Clearly there are risks, but it seems to me that Lonmin has a reasonable chance of getting into a situation where it can breakeven and generate a modest profit. In my opinion, such proof of the firm’s viability might be enough to trigger a substantial rise in the share price.

Although I think Lonmin remains risky, I also think the platinum sector may be moving into contrarian territory. I am considering a small buy.

Disclaimer: This article represents the author’s personal opinion only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.

Iron ore

Anglo American and BHP Billiton — what next for my biggest losers of 2015?

Iron oreDisclosure: I own shares in Anglo American and BHP Billiton.

I’ve updated this article in the light of Anglo’s “radical restructuring” presentation on the 8 December.

Value investors are often accused of buying too soon and selling too soon.

But I can’t use that as an excuse for my poorly-timed purchases of Anglo American and BHP Billiton.

I just got it plain wrong. I massively underestimated the scale of the cyclical downturn taking hold of both companies.

For example, I took comfort from Anglo’s positive cash flow during the first half of 2015, without really considering how much further commodity prices might decline.

I can be slightly more charitable about my mis-timed entry to BHP, as much of the recent decline was caused by the Samarco tragedy in Brazil — something which couldn’t really have been foreseen.

An investor using stop-losses would have sold out a long time ago, but I don’t use stop losses and decided not to sell.

I don’t use stop losses for two reasons:

  1. I like to decide when to sell a stock on its merits or otherwise. I don’t mind sitting on a loss if I’m comfortable with the firm’s longer-term outlook.
  2. My limited experience of using stop losses suggests that more often than not, I’ll be stopped out of a position I want to keep, and vice versa. I would only consider using stop losses for a purely mechanical strategy, with no discretionary trading decisions.

Anyway, I didn’t sell BHP or Anglo, and am now sitting on a loss of around 45% on BHP and Anglo. Ouch.

What’s the plan?

I think we must be close to the bottom, although we may not be there yet. The valuations of most of the big miners (and big oil) are starting to imply that things will never improve. That’s unlikely, in my view, although there may yet be further pain, especially for Anglo shareholders…

Update: 09/12/2015: Anglo’s Investor Day presentation yesterday was a fairly seismic event. The firm is planning to sell, shutdown or place onto care and maintenance programmes roughly 60% of its assets. The dividend will be suspended until at least the end of 2016 and then reinstated as a percentage of earnings, not a progressive policy.

The shares closed down 12% on the day.

In my view, this plan should enable the firm to survive and manage its $13bn debt burden, but we won’t see any more detail until February. It’s fair to say that what the firm is suggesting is more radical than anyone expected.

I remain a holder for the long term but would not buy (again) until greater clarity emerges.

I don’t see the point in selling now at what might be a low point for both sentiment and commodity prices. Instead, I’ve bought more shares and averaged down my Anglo position. I would be happy to do the same for BHP but don’t currently have enough spare cash in my portfolio to do so.

My logic is that while I mis-timed the cycle, I remain confident that both BHP and Anglo will make decent recoveries. On that basis, I need to lower my average purchase price to improve my chances of a decent profit when the recovery comes.

After yesterday’s update, my confidence in Anglo’s recovery is somewhat diminished but I remain a holder and suspect that something of value will emerge out of the wreckage.

At BHP, on which I am more confident, a net profit of $2.5bn on sales of $34bn is forecast this year. That’s hardly terminal. BHP shares trade at tangible book value and the firm’s balance sheet remains strong enough to cope, in my view, especially if the dividend is cut.

I remain a holder of both shares.

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.

A tunnel in a deep mine

Lonmin enters last chance saloon with $407m rights issue

A tunnel in a deep mineDisclosure: I have no financial interest in any  company mentioned in this article.

Lonmin’s decision to raise $407m (£270m) through a 46-for-1 rights issue means two things:

  1. Shareholders who choose not to take part will be diluted out of existence — the number of new shares mean dilution will be 97.5%.
  2. If Lonmin cannot make this work, shareholders are toast; the company is likely to go into administration and the shares to 0p.
  3. The only people guaranteed to make a profit out of this are the banks underwriting the offer. They’ll be collecting a cool $38m in fees. That’s more than 10%. Nice work if you can get it.

Lonmin’s spectacular 95% discount to its stated book value has been a potent reminder of the writedowns and dilutive re-financing we all knew must be in the pipeline.

Since the rights issue was announced yesterday, Lonmin shares have continued to fall. As I write they are down by 35% on Tuesday and by 43% so far this week. Many shareholders have obviously decided that faced with a choice between a big loss and funding Lonmin’s third major rights issue since 2009, they will sell.

Here’s a summary of what the rights issue will mean. All these figures are estimates based on my calculations. Naturally they may contain errors and will rapidly become out-dated — please do your own research before making any investment or trading decisions:

  • Rights issue price: c.27bn new shares at 1p
  • Ex-rights price (based on last seen 10p share price): 1.2p
  • Estimated value of nil paid rights: 0.2p (i.e. 9.2p per existing share)
  • Estimated price/book ratio post-rights issue: 0.2

These numbers will change continually until the shares go ex-rights. If Lonmin shares continue to fall, the ex-rights price and the potential value of the nil-paid rights will fall further. In my view there is no reason to consider an investment until after the rights issue, when the flood of new shares hits the market.

Mucho problemo

On the face of it, Lonmin has a stronger balance sheet than heavily-indebted Petropavlovsk, which also carried out a massively dilutive rights issue earlier this year. Lonmin’s net debt isn’t excessive but the firm’s other problems make it potentially much more risky than Petropavlovsk, in my view.

The obvious issue is that the firm’s reported platinum group metals (PGM) basket price fell from $1,013/oz in 2014 to just $849/oz in 2015. In 2011, it was $1,300/oz. Can Lonmin restructure its operations in order to generate free cash flow at the current price? Perhaps, but the firm faces a wide range of obstacles.

This article by Reuters columnist Andy Critchlow does a good job of explaining the issues, but in brief Lonmin must deal with a weak and uncertain platinum market, labour-intensive, aging mines with a highly-unionised workforce, and the difficult political and social environment in South Africa.

After all, it’s only 3 years since 34 Lonmin workers at the firm’s Marikana mine were shot by police. The company was not found to have broken any laws, but was criticised by a subsequent judicial inquiry for not doing enough to prevent the outbreak of violence.

In my view, investors need to consider the nature of the problems that led to this tragedy, which would be inconceivable in most other parts of the world:

  • Is South Africa a safe investment environment?
  • Do you want to fund a company which has for many years been happy to profit from workers whose poverty and inequality drives them to such extremes?

Lonmin has been a toxic investment since at least 2012, in my view. I believe there’s still a fair chance the firm could go bust leaving shareholders with nothing. However, I will look again at the investment opportunity after the rights issue takes place.

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.

An open-cast coal mine

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

An open-cast coal mineDisclosure: 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.

Iron ore

Market correction portfolio update / BHP Billiton results review

Iron oreDisclosure: I own shares of BHP Billiton.

Monday’s market correction wasn’t a lot of fun.

Clearly I had made the classic value investing mistake of buying too soon with some of my recent purchases, especially in the commodity sector.

Yet the logic behind each purchase remains valid, as far as I can see, so I did the only sensible thing to my portfolio on Monday — absolutely nothing.

I haven’t bought or sold a share this week. I should say that if funds had permitted I would have topped up on a number of stocks, but sadly I was already pretty much fully invested. Possibly a lesson for the future.

What about BHP?

Moving on from that, yesterday’s results from BHP Billiton plc (LON:BLT) coincided with a market rebound. The big miner ended the day up by around 6%.

I was encouraged by the figures, too. The firm maintained its progressive dividend commitment, inching up the payout by 2% to 124 cents.

However, as I’ve said before, in my view the most important financials in the current environment relate to cash flow. A company generating positive cash flow with a well-structured debt profile won’t run into trouble.

Cashflow & capex

BHP appears to score highly in the cash flow department. After stripping out the assets that have been divested, mainly into South32, we get the following:

  • Net cash flow from continuing operations: $17.8bn
  • Net cash ourflow from investing in continuing operations: $11.5bn.
  • Free cash flow from continuing operations:$6.3bn.
  • Price-to-free cash flow ratio of 13.5 (continuing operations)

Although net repayment of debt and dividend payments totalled $7.2bn, I think this is a pretty strong cash flow result in the circumstances.

Reducing its cash balance from $8.7bn to $6.6bn also BHP to reduce net debt by $1.4bn to $24.4bn during the period, which should help to protect its credit rating.

It’s worth reiterating the value of BHP’s ‘A’ credit rating. The last time the firm issued new debt, in April, it was able to sell 2030 bonds with a rate of just 1.5%. That’s lower than most governments can manage.

BHP plans further cuts to capex for the coming year. Planned expenditure is expected to fall from $11bn in 2014/15 to $8.5bn in 2015/16, and to $7.0bn in the 2016/17.

I suspect this will be enough to protect the dividend and the firm’s balance sheet strength, although it’s not possible to be certain at this point.

Outlook

Given BHP’s balance sheet strength and cash generating ability, the firm’s 7%+ yield alone would be enough to make it a buy at the moment, in my view. A trailing P/E ratio of 13.5 backed by free cash flow is also pretty decent.

Although BHP’s earnings are expected to fall again in the coming year, I believe the big miner remains a buy, and will continue to hold.

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.

An open-cast coal mine

Hargreaves Services plc: on course but destination uncertain

An open-cast coal mineDisclosure: I own shares of Hargreaves Services.

Results from Hargreaves Services (LON:HSP) earlier this week made interesting reading.

The dividend increase to 30p per share was welcome, as it is backed by cash and covered twice by earnings per share. However, there’s no point in pretending that this payout can be maintained, as profits are falling as the firm’s primary coal market continues its structural decline.

Hargreaves says it is targeting a move to a 40% payout ratio and this is reflected in the latest broker forecasts, which show the payout dropping to 21.9p for the current year, and to 18.5p in 2016/17.

Still a coal firm

I think the biggest takeaway for shareholders is that this is still a coal firm. £33.4m of the group’s underlying operating profit of £40m came from coal production, trading and distribution last year. Operating profit from transport (which is diversifying into waste and biomass) and industrial services (outsourced coal supply chain/facility management in the UK and abroad) only totalled £5.5m.

Hargreaves has completed its simplification programme (at a cost of £12m) and is now focused on shifting its strategy for a future without coal mining. Incidentally, the cost of the simplification programme was originally expected to be around £7m, so this seems to have overrun. However, looking the this week’s accounts suggest that the bulk of the extra cost relates to derivative losses, presumably relating to the falling price of coal.

At the moment, the firm’s strategy appears to focus on onshore wind and housing development, using its land assets in Scotland and England. However, it’s too early to say how successful these ventures will be, especially in the face of proposed changes to the subsidy and tax structure for onshore wind.

Hargreaves recognises this and states that its planning is based on the assumption that the wind-down of coal power in the UK will take longer than expected, due to the need for reliable base load generation. Hargreaves’ view is that supplying coal to power stations and steel works will continue to provide the firm with a viable business until 2020.

I’m not in a position to judge the accuracy of this forecast, although it doesn’t seem unrealistic, given the current lack of investment in new power stations.

Still a buy?

One point I think is worth commenting on is the quality of the Hargreaves market communications. I find them to be unusually candid and open, on the whole, and very easy to understand. One exception is that banking covenants are not specified. Instead, the firm simply states that it is operating “comfortably below our covenant levels”. What does that mean?

If Hargreaves’ prognosis that the coal business will survive in its present form for a few more years is correct, then the firm’s shares look reasonable value.

They currently trade on around 4 times 2014/15 earnings and 8 times forecast 2015/16 and 2016/17 earnings, with a yield dropping from nearly 9% this year to just over 5% in 2016/17.

Cash generation and the balance sheet remain strong and the firm’s management has so far proved willing and able to take effective actions to reduce costs and realise value from unwanted assets.

However, one concern I do have is that the current hedging and fixed price contracts all ended in May. As the company admits, these supported the strong profits from the mining business over the last year. It’s not clear to me how this will impact forecast revenues this year, if coal prices do not pick up in the next few months.

Overall, there’s no denying that this is an uncertain picture. However, it may be worth noting that so far, things have turned out broadly in-line with management guidance. On this basis, I intend to hold unless/until something material emerges to change the picture.

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.

 

A falling knife.

Lonmin Plc: Value buy or value trap?

Should you catch a falling knife?

Lonmin may be a falling knife. Beware.

Disclosure: I have no financial interest in any  company mentioned in this article.

Update 10/11/15: I’ve written a new post taking a look at Lonmin’s planned rights issue — click here to read.

Update 23/10/15: Earlier this week Lonmin announced plans for a $400m rights issue. The firm has managed to secure a promise of new banking facilities, conditional on the rights issue.

This was pretty much inevitable and is logical. Indeed, it’s better than it might have been. However, it’s not the first time this company has handed the hat round in recent years. I discussed the news further in an article for the Motley Fool earlier this week.

In a nutshell, my view is that we haven’t yet seen any  hard numbers to prove that cash flow has turned positive. We also don’t know how dilutive the rights issue will be and whether it will be well supported.

There’s no rush to buy until at least one of those questions has been answered, in my opinion.

——

Original article from 28 July 2015 starts here:

The recent slide in commodity stocks has been uncomfortable for shareholders in many companies, but devastating for those owning shares in South African platinum miner Lonmin Plc (LON:LMI).

The firm’s shares have fallen by 54% to 57p over the last month, taking their 12-month decline to 77%.

Lonmin shares now trade at an 80% discount to the firm’s latest reported book value. In this article I’ll ask whether this is a deep value opportunity, or simply a value trap.

1. Book value

Let’s deal with the question of book value first. According to Lonmin’s interim results, the firm had a tangible net asset value of 311p per share. At last night’s closing price of 57p, that puts Lonmin shares on a price/tangible book ratio of just 0.18.

As with anything that seems too good to be true, this is.

Lonmin announced plans to suspend operations at some of its mine shafts on Friday. Unless we see a platinum bounce or the firm manages to find a way of operating these shafts at much lower cost, I suspect the value of these assets will have to be written down sharply when Lonmin’s accounts are next made up.

Most of the big miners have been forced to write down the book value of some of their assets. Lonmin’s discount to book value is, in my view, a reflection of likely impairments and the firm’s lack of profitability.

2. Cash flow and profits?

Value investing is all about finding investments that are cheap enough to offer a margin of safety — protection from permanent loss of capital.

Lonmin admitted on Friday that its operations are currently “EBITDA negative”. Translated into English, this means the firm is operating at a loss, probably quite badly. It seems fair to assume that cash flow is negative, too.

During the first half of the year, underlying EBITDA was only $8m. Since the start of Lonmin’s H2, platinum has fallen by a further 14%, from $1,126 to its current level of about $980 per ounce.

Lonmin is attempting to staunch the losses by closing the high cost Hossy and Newman shafts and focusing on the cheapest, most easily mined reserves. However, there’s no guarantee that this will be enough to return the firm to positive cash flow or EBITDA.

Based on its perilous earnings and cash flow situation, Lonmin isn’t a value buy.

3. Cash reserves?

Companies can afford to run at a loss for a while if they have a strong balance sheet, and/or cash reserves. Lonmin has neither.

The firm’s interim results showed that by 31 March, Lonmin had net debt of $282m, meaning that the firm had used up half of its $563m of borrowing facilities. Net debt is almost certainly higher today, and in Friday’s update Lonmin confirmed that it is “reviewing the appropriate capital structure” for the company in the light of “the need to re-finance our debt facilities”.

An update is expected by the time of Lonmin’s full-year results in November. Whatever combination of debt or equity is agreed on, my view is that it is likely to be heavily dilutive for shareholders, unless they are willing to put in a substantial amount of fresh cash.

As a result, Lonmin fails as a potential value investment on balance sheet strength.

Conclusion

In my view, Lonmin fails on all three core tests of value: assets, earnings and cash flow, and cash/debt.

I’m not surprised Glencore dumped its shares in the miner: as a major shareholder holding 23.9% of the stock, Ivan Glasbenberg’s trading giant was probably keen to avoid the risk of being on the hook for any cash in a placing or rights issue.

From here, Lonmin shares could easily triple or fall to zero. Buying Lonmin stock today is a punt, not an investment, in my view. As such, I’m going to continue to avoid it.

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.

An open-cast coal mine

Anglo American interim results: dividend held, challenges remain

An open-cast coal mineDisclosure: I own shares in Anglo American, Rio Tinto and BHP Billiton.

Half-year results from Anglo American (LON:AAL) today coincided with another lurch down for the commodity market, but I don’t think there was anything specific in the firm’s results to single it out.

As I write, half an hour before markets close on Friday, Anglo is down 3%, BHP is down 4% and Rio is down 3.6%.

(Lonmin is down 18%, but that’s another story — one which I plan to take a closer look at in another post in the next few days. I’ve viewed Lonmin shares as toxic for the last two years, but is it time to take a punt on this firm, which trades at around a 75% discount to book value? We will see.)

Getting back to Anglo, today’s results were broadly as expected. Underlying EBIT (operating profit) of $1.9bn was 36% lower than during the same period last year. This fall was simply due to commodity price reductions, which also prompted the firm to make $3.5bn of impairments, including $2.9bn at the Minas-Rio iron ore project.

The interim dividend was maintained, to some investors’ surprise. However with the prospective yield now at 6.8%, this situation can’t last forever. Unless iron ore prices, or perhaps copper and platinum, rebound fairly soon, a dividend cut seems inevitable, in my view.

Better than expected?

The good news for shareholders is that Anglo is still profitable at an operating level. The firm also said today that it’s targeting a further $1.5bn of cost cuts during the second half, including $800m of operating cost cuts. An additional $1bn will also be cut from planned capital expenditure. These savings may go some way to help offset commodity price weakness.

Better still was news that the sale of its Lafarge business has enabled the firm to reduce net debt from $13.5bn to $11.9bn. This was much needed.

However, looking ahead in the near term, we have to accept that there isn’t much that Anglo CEO Mark Cutifani can do about commodity prices. He may also struggle to achieve an acceptable price for any asset sales, making this route unappealing.

On this basis, it makes sense to look at cash flow. Can Anglo remain self-sufficient without slipping further into debt? If so, then I may consider buying more shares and averaging down my holding.

Cash flow analysis

Let’s take a look at the cash flow statement for H1 2015 (you can see the full accounts here):

  • Net cash inflows from operating activities: $2,715m
  • Net cash used in investing activities: $2,343m
  • Net cash inflows from financing activities: $24m*

At first sight, this doesn’t look too bad and suggests that Anglo did generate some free cash flow in H1. However, that’s not really the case, at least not from an equity investor’s perspective.

I always calculate free cash flow as operating cash flow – investing cash flow – interest payments.

This is because from an equity perspective, free cash flow is only relevant if it still exists after a firm’s debt commitments have been satisifed. Remember that debt always ranks above equity. As Afren shareholders have found recently, trying to deny this basic reality can prove costly…

Anglo’s free cash flow before interest payments was $372m. Unfortunately this was wholly absorbed by interest payments of $456m. There was no free cash flow to fund the $876m of dividend payments made during the period.

However, Anglo’s financing cash flows show that borrowing fell by a net $545m during the first half, and that the firm issued $2,159m in new bonds. We also know that net debt fell by $1.6bn after the half-year ended, thanks to the Lafarge sale.

The net effect of these refinancing activities has been to reduce short-term debt and moderately increase long-term debt. Pushing repayment dates further into the future is sensible, especially given that the firm’s newer borrowings may be at lower rates than the retired debt. I’d expect Anglo’s interest payment for H2 to be slightly lower than H1.

I’d also hope that some of the firm’s targeted operating cost savings of $800m will feed through to operating cash flow in H2. However, offsetting this will be the full impact of recent commodity price falls, many of which took place towards the end of the first half. Unless prices rebound during H2, my view is that operating cash flow is likely to fall again during the second half of the year.

The verdict?

It’s a complex picture with a number of moving parts. Assuming commodity prices don’t fall much further, my feeling is that the gains and losses will broadly offset each other during the second half. This will give a similar picture to that which we’ve seen today — cash flow breakeven excluding dividend payments.

Anglo does still have more than $7bn of undrawn borrowing facilities, so it isn’t going to run out of cash. However, it makes no sense for the firm to to use borrowed money to pay dividends for more than a short period.

I’m tempted to average down on Anglo next week, but will mull it over during the weekend before making a final decision. The big risk, of course, is that we haven’t yet seen the bottom for commodities…

N.B. 27/07/15: I’m not going to average down on AAL for now, as I don’t want to go any more overweight in commodities than I already am. But I would be tempted to expand a smaller position.

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.

Iron ore

A low point for miners? Why I’ve bought Anglo American plc

Iron oreDisclosure: I own shares in BHP Billiton and Anglo American.

I’ve been watching the big mining stocks for some time, believing that at some point they will become good value buys.

I’ve owned shares in BHP Billiton for some time — and I’ve now added Anglo American plc (LON:AAL) to my portfolio.

In a recent article for the Motley Fool, I mused on the growing value appeal of Anglo American. As often happens, writing about the firm helped crystallise my thinking and prompted further research.

To save on typing, here is an extract from my research spreadsheet, which I use to build up a picture of a firm before deciding whether to invest. Based on these numbers, I believe that Anglo is getting close to the bottom:

TTM P/E TTM yield PE10 P/B P/TB P/S Current Ratio Dividend cover (adjusted eps) FCF dividend cover Cash interest cover Net gearing
8.60 5.70% 5.9 0.65 0.75 0.8 2.1 2.0 n/a 7.3 37%

A trailing P/E of 8.6, a PE10 of 5.9 and a P/B of 0.65 were particular appeals, as is the yield and reasonably healthy balance sheet. Net debt is expected to peak this year, after which it should fall.

Anglo still has some problems to face in restructuring its South African coal and platinum operations. However, the bigger question seems to be over the outlook for commodity prices.

In my view, demand for iron ore, coal and even platinum isn’t going to fall of a cliff. Nor are commodity prices, at least not below current levels, in my view. This is a view backed by some City heavyweights. This set of 2015-2020 commodity forecasts from a major broker (courtesy of the always excellent Value Perspective blog) is well worth a read.

It’s worth remembering that all of Anglo’s divisions delivered an operating profit last year. This company has problems, but it isn’t a basket case:

aal-fy2014-ebit

Source: Investegate/Anglo American

Why buy now?

I’ve been watching Anglo’s share price decline for a while. Why have I chosen now (well, 17 June) to buy?

There were several reasons.

Firstly, I’d had in mind a target buy price of below 1,000p. When the shares dropped to 968p, my target was hit and the price seemed fair, given the facts at hand. Anglo now trades at a severe discount to Rio and BHP in terms of P/S and P/B ratios. This should give decent upside potential if CEO Mark Cutifani can deliver a successful turnaround.

There were some less tangible reasons for my buy, too. For example, I noticed a piece titled, Investors press Anglo American chief executive for cost cuts” in the FT on Wednesday.

Such pieces often appear in the pink pages when big cap firms are struggling to deliver the goods. They are, I believe, the result of PR pressure by big investors and often seem to precede the very improvement they are demanding.

Finally, market sentiment towards the big miners seems to be hitting a serious low. As I explained in my Motley Fool article, earnings forecasts have been slashed in recent months. As and when this sentiment starts to improve, so will these firms’ share prices. It’s worth remembering that markets always strive to be forward looking. As soon as they get a sniff of good news, it will be priced in.

Therefore for contrarian investors, the best time to buy is often when sentiment seems hopeless.

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.