Friday, Aug 08, 2003
Anglo American stock has long traded at a discount to that of its mining rivals, Rio Tinto and BHP Billiton, mainly because of its exposure to South African political risk.
But Friday's encouraging first-half results from Anglo, following Rio's announcement of disappointing first-half figures last Thursday, mean the market may look again at the gap in valuations.
Anglo, which has a market capitalisation of about GBP15.3bn, said yesterday its net profits including goodwill amortisation for the first half of 2003 were $856m (GBP529m). Rio's market capitalisation is slightly bigger at GBP17.7bn, while its first-half net profits including goodwill were lower at $678m.
Based on p/e forecasts, Anglo's shares trade at a 10 to 15 per cent discount to Rio stock. Anglo's shares dropped sharply 12 months ago when the South African government's black empowerment plans, including a compulsory transfer of some mining assets to black ownership, were leaked. But the measures have since been watered down and Anglo shares have outperformed Rio this year, causing the gap to narrow.
The differing fortunes of Anglo and Rio largely stem from their asset portfolios. Among the larger mining groups, swings in commodity prices and currency exchange rates dictate who makes a profit much more than factors such as cost control and good management. Both companies were adversely affected by currency moves - Anglo by the South African rand's strength and Rio by a rising Australian dollar - which inflate costs. But Anglo has benefited most from commodity price trends.
Anglo is strong in precious metals, diamonds and paper and packaging, all businesses that are doing well because of strong demand and high commodity prices. These divisions supplied almost three-quarters of Anglo's first-half profits, 29 per cent coming from De Beers' diamonds alone.
Rio has a very different mix of assets - one that is less in vogue. Its business is concentrated in iron ore, coal and base metals, although Rio does have a growing presence in the diamond industry through its mines in Canada. Depressed prices in commodities such as coal, copper and aluminium took a chunk out of first-half profits. But Rio's business mix, particularly its strength in iron ore, mean it may be best positioned in an economic upturn. Base metals prices for copper and zinc tend to rise with higher economic growth and analysts say Rio's base metal assets are of a higher quality than Anglo's.
Iron ore prices are rising and some analysts predict a boom as demand is starting to outweigh supply. Rio made $215m from its iron ore operations in the first half, almost a third of its profits, and achieved a 44 per cent rise in exports to China.
China is often cited as a positive factor for mining company profits. Rio and BHP Billiton have been ahead of the market in capitalising on Chinese commodity demand, while Anglo has been more reticent in entering that market. "Doing business in China is not without risks," said Tony Trahar, Anglo American's chief executive. "We will continue to feel our way forward cautiously there."
Although mining profits are governed by commodity and currency prices, investors increasingly look at transparency and good management. Anglo is working hard to shake its traditional reputation for poor financial disclosure and cut $127m of costs in the first half.
Charles Kernot, mining analyst at BNP Paribas, thinks this is another reason why Anglo's share discount should fade away. "Rio has been very well managed for a long time and cut lots of costs in the 1990s. Anglo is now doing the sort of things Rio has done historically, so you would expect the share price to catch up too."
Rebecca Bream
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