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SIF Folio: Could Anglo American still be cheap?

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The big miners are reporting incredible profits at the moment, thanks to a China-led boom in commodities since last year’s crash. Dividend yields have inflated to match — my subject today, Anglo American (LON:AAL), has a 2021 forecast yield of 8%.

This South Africa-focused FTSE 100 group is a new arrival in my screening results. It’s also currently one of the top-ranked UK shares on Stockopedia:

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I’ll say now that I won’t be adding Anglo American to SIF because I already hold commodities group EVRAZ (LON:EVR), which produces coal, iron ore and steel. But I will give a definitive answer on whether I’d buy Anglo for SIF if I didn’t already hold a rival miner.

Why is Anglo doing so well?

Anglo has outperformed its FTSE 100 rivals BHP (LON:BHP) and Rio Tinto (LON:RIO) over the last five years:

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I think that one reason for this is the company’s more evenly balanced mix of commodities. Broadly speaking, Anglo has a greater weighting to late cycle commodities such as copper, platinum and diamonds than Rio or BHP.

We can see how Anglo American’s profit split is significantly different to Rio’s in this table:

Underlying EBITDA (%) H1 2021

Commodity

Rio Tinto

Anglo American

Iron ore

75%

40%

Platinum group metals

0%

36%

Copper

10%

16%

Aluminium

9%

n/a

Diamonds

n/a

5%

Other minerals/coal

6.5%

2.5%

Where next for Anglo?

Anglo American’s performance and valuation metrics certainly look tempting at the moment. How often will you see a single-figure P/E, double digit EPS growth and a 6%+ yield? 

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Stockopedia’s algorithms like the shares too. AAL stock currently boasts a StockRank of 99 and Super Stock status. 

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I can see the ongoing appeal of these shares, but I can also see some reasons to be cautious. In the remainder of this piece, I’m going to drill into Anglo American’s QVM scores and attempt to put the current numbers in context.

Disclosure: There is a severe risk that seller’s remorse could distort my views about this business. I bought Anglo shares at prices between 378p and 900p during the second half of 2015. I then sold for 1,100p+ during the first half of 2017. Had I sat tight and done nothing, the value of my holding would have tripled since those sales. 

Fortunately, the experience reinforced a key lesson of investing in commodity producers. In my view, we should never be tempted to look at these companies as normal businesses. They are leveraged plays on commodity prices. What seems inevitable today might seem unlikely in 12 months’ time.

With that thought in mind, let’s take a look at Anglo’s factor scores.

Value: the shares are getting cheaper!

Anglo American’s ValueRank of 89 looks encouraging. Although the shares have risen by 70% over the last 12 months, profits have risen even more quickly. 

Operating profit for the first half of 2021 was $11.2bn. This was almost double the $6.3bn reported for the whole of 2020. 

In total, Anglo has generated an operating profit of $15.6bn over the last 12 months. That gives the stock an earnings yield (EBIT/EV) of 20%. That’s one of the highest earnings yields I’ve ever seen in my SIF screening results. 

There is a caveat here – around 28% of the group’s underlying earnings are attributed to non-controlling interests. These are minority shareholders of Anglo’s subsidiary companies. 

Adjusting for this, the shareholder earnings yield falls to about 14.5% – still very cheap.

The stock’s apparent value is supported by other key metrics:

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However, to understand Anglo American’s current valuation I think we need to look further back than the trailing 12 months covered by the ValueRank. Fortunately, we can do this by switching to the accounts tab on the StockReport.  

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The historical data show us that despite current bumper profits, Anglo is currently a less profitable business than it was 10 years ago:

  • In 2011, the group reported revenue of $31bn and operating profit of $9.6bn. 

  • In 2020, revenue was also $31bn, but operating profit was just $6.1bn.

Broker forecasts suggest that Anglo’s operating profit in 2021 will be $9.7bn. This should match the previous peak from 2011. However, forecast revenue of $44bn (2011: $31bn) means that profit margins are expected to remain much lower than in 2011.

I don’t see much evidence of a structural growth story here. From 2012 until 2020, revenue and profits were both below the high watermark established in 2011. 

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An alternative way to look at the valuation of cyclical companies is by averaging their profits over 10 years. This is known as the PE10 or CAPE (cyclically adjusted PE). 

When I bought my Anglo shares back in 2015, the stock traded on a low single digit PE10. Today, the PE10 is 21, according to Stockopedia data. 

In my view, we’re now approaching the peak of another commodity cycle. Anglo American’s share price chart reinforces this view, in my opinion. I don’t see much reason to think this is a more valuable business than it was 10 years ago.

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In summary, I agree that Anglo American shares look cheap today. But I think it might be wise to view these figures in a broader historical context. Cyclical stocks always tend to look cheap at the peak of the cycle, when profits are at record highs.

Quality: Great, but still cyclical

I believe Anglo American’s quality metrics tell a similar story. Profitability has improved steadily in recent years, but this year’s figures look set to be a blowout:

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The business is churning out incredible amounts of free cash flow, too. 

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To put these numbers in context, Anglo generated $5.4bn of free cash flow during the first half of 2021. Of this, $4bn is being returned to shareholders through dividends and buybacks. This means that in just six months, the company is returning an amount to shareholders that’s greater than its underlying annual net profit from 2019 or 2020.

However, what makes this situation interesting is that even if Anglo American’s profits do start to fall in 2022, the shares could still offer decent value. Let’s see what the momentum data show us.

Momentum: Strong positive trend

Anglo American’s MomentumRank of 98 reflects a near-perfect setup of rising share price and rising broker forecasts. The figures certainly highlight some strong trends.

Price Momentum: Anglo American scores well here, with a sea of green:

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Earnings estimates: I tend to be fairly sceptical about earnings forecasts for miners, which are volatile and mostly just reflect commodity price movements. In my view, the main value of these forecasts is the trends they highlight. 

In this case, we can see that earnings are expected to fall in 2022 and the profit gap is getting wider:

V7t6I7OjJPWxwWPRYtLUbLf-8J7MpV1-nVzEpV2yMy verdict: is it different this time?

Fund manager Sir John Templeton reportedly said that “the four most dangerous words in investing are: this time it’s different”. I agree with this sentiment.

Of course, there are some compelling arguments to suggest that things really could be different this time – or at least that the current boom conditions may continue for longer than expected.

Firstly, miners like Anglo American have maintained discipline on capital spending remarkably well since 2016. They’ve focused on shareholder returns and resisted the temptation to splash out on large new projects or acquisitions.

Second, the global need to cut carbon emissions seems likely to drive a structural increase in demand for copper and some other minerals. 

Both of these are convincing arguments, but I’m more swayed by another commodity market adage: the cure for high prices, is high prices. 

If commodity prices are high and demand stays strong, sooner or later supply will increase (miners will increase capex) or demand will reduce (buyers will find ways to reduce their dependence on expensive materials).

My view is clear enough. I wouldn’t buy Anglo American for SIF at this point in the cycle. However, I accept that in reality, it may be too soon to turn cautious.

As always, please let me know what you think in the comments. Am I about to suffer the curse of being right, but at the wrong time?

Stockopedia



Source: https://www.stockopedia.com/content/sif-folio-could-anglo-american-still-be-cheap-855649/


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