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.