Des Kilalea, RBC Capital Markets mining analyst on Anglo American's Reults

Barry Sergeant discusses Anglo American's results, the passing of its dividend and iron ore with RBCCM's Des Kilalea

BARRY SERGEANT:  In this podcast from Johannesburg, I am speaking with Des Kilalea who is mining analyst of RBC Capitalist Markets in London.  Des, we have had the Anglo American results out today.  It is the last of the major mining companies to report.  Was there anything unexpected as far as the professional investor is concerned in the results?

DES KILALEA:  Barry probably two things.  The first was the size of the impairments at over R2bn.  That came out of the blue.  It is not unexpected but it was a little out of the blue and the second may have been to some people, the decision not to have paid a dividend given that Xstrata and Rio Tinto both paid dividends.  That would have been the two things that may have surprised people. 

BARRY SERGEANT:  Right. One of the things you were saying about Anglo American over the past while going back to '06, if you take the stock buybacks, '06,'07 and '08 it adds up to about US$10bn and the dividends over that period are about US$6bn.  Wouldn't Anglo American, and one doesn't take sides here, wouldn't they maybe argue that they deserve some kind of a dividend holiday during 2009 or is that just not the kind of thing investors would buy?

DES KILALEA: I didn't find the passing of the dividend particularly poisonous.  As far as I am concerned, and theory would support me, if you have got a better use for the money then why give it back to shareholders and arguably their share buyback scheme was not the best planned, but that's with the benefit of hindsight.  Cutting the dividend was because they had too much debt and they had very large capex requirements.  So, I think if a company can do better with its cash than giving it back to you as a shareholder, so be it.  But what you need to do is to ensure that your shareholders know what your strategy is and I think that was the problem.  The suddenness of ‘wow suddenly no dividend'.  

BARRY SERGEANT:  That was a surprise and also Anglo American has been humping along since 1917 and as far as anyone seems to know this is the first time in '09 hat they passed a dividend.  So there are, I guess people that were thrown into fits of deep depression.  They just couldn't believe what had happen although that is more to do with investor, bearing in mind, certainly in South Africa that Anglo American investors are at this stage what you might call pensioners, so it was just completely out of form for them. 

DES KILALEA:  It was.  It was a dividend stock and so the real shock - and it's probably with the benefit of hindsight - Anglo perhaps should have signalled that there was a possibility of a change in its dividend policy. 

BARRY SERGEANT:  To go back to the debt question, after Rio Tinto and Xstrata, if my numbers are right, Anglo American is the third most indebted mining company globally - the figure didn't really change.  End of '08 $11bn net debt that includes cash, staying about the same level at the end of '09.  The other cash flow pressure which certainly showed up at the end, during '08 was the purchase by Anglo American of Minas-Rio in Brazil which of course is very substantial.  We heard today it's got 5bn tonnes now of resources.  It also needs billions of dollars to develop.  What is your reading on Minas-Rio, both as to cost on the capital investment, the development cost and also the outlook for the operation?

DES KILALEA:  There is no question that Anglo American overpaid for Minas-Rio to the extent that they raked $1.5bn off the Amapá iron ore project which came in as part of Minas-Rio, tells you that alone.  It's not beyond possibility that there could be further right offs although the development of increased resources probably will prevent that being a requirement.  So the capital that they paid was too much.  They have increased the capital allocated to the project from an original of about $3.6bn to $3.7bn in total to $5bn.  There is no absolute question in my mind that this is the single biggest project risk that Anglo has on its books right now.  It's potentially a vast iron ore system and should actually deliver material at the coast at a fraction of the iron ore price.  So the economics look very good and the fact that they have overpaid is almost history now because every dollar they invest from hereon, the purchase price has been paid, it is gone.  So it is a good project but they overpaid for it though. 

BARRY SERGEANT:  Of course looking at the breakdown of earnings for 2009, two of the big carriers for Anglo American were copper - which has been a global phenomenon across the other groups and the other commonality, iron ore, and that of course came from Anglo American's 64% South African subsidiary, Kumba Iron Ore.  So we do know that generically iron ore is a very good place to be along with coking coal.  Anglo American today also said that other areas it was staying in and growing were nickel and diamonds.  Those are certainly to some, a bit of surprise - any comments in those two areas?

DES KILALEA:  Yes I would agree to the prognosis of iron ore is great and Kumba is a great business and we have spoken about Minas-Rio.  Nickel is rather unusual given that we have heard that BHP Billiton publicly say that the existence of Chinese pig-iron basically takes away some of the volatility and the spikes which reduces the return on the assets over the cycle.  So BHP Billiton has - not exited - but is not putting any new money in unless they find something really good.  I think Anglo American's decision to be bigger in nickel is really driven by project-specific things.  For example Barro Alto in Brazil where they hope to have upgrading costs of about $3 to $3.50/lb of nickel and the price of nickel today is $9 and let's say it goes even to $6, they have still got a very healthy margin.  So I think the fact that they have got Barro Alto on the books is probably part of the reason why they are very positive.  Diamonds is something that is a different cycle, it's a late cycle business, it is a luxury product.  I don't think Anglo American has any choice but to keep its diamond investment right now because it is only turning.  I am not of the opinion that diamonds will be part of the portfolio in five years.

BARRY SERGEANT:  It's a very interesting one and there is a lot of discussion whether it is around dinner tables, or elsewhere, about the future of De Beers.  I don't know if you have had any time to start crunching your numbers for 2010 but just focussing on operating cash flow '08 about just over $8bn at Anglo American - that roughly halved at '09 to about $4.1bn which didn't quite cover capital expenditure of $4.6bn.  Where do you see that operating cash flow going forward in 2010 and maybe after that? 

DES KILALEA:  In general you are going to see significantly enhanced cash flow across all the groups and Anglo American's earnings growth should be of the order of 30% to 40% this year and operating cash flow will probably grow a little quicker than that and probably of the order of 50%.  So it should be a pretty good outlook and that is why they are not worried about their balance sheet because they have got $6bn capex to spend this year, a lot of which is on projects - about $1.8bn on stand-business capex and the rest will be on the big projects and that capital peaks this year.  So in 2011 and 2012 they should generate very significant cash flows.  We have got ... if we were to look at our numbers for cash flow per share for next year - we would see something of the order of $6 and that as I say is 50% to 60% up on last year. 

BARRY SERGEANT:  That is very attractive.  What would that do after capital expenditure, what would that do to the net debt which ended up '09 at US$11bn. 

DES KILALEA:  Okay, they said that their debt, after the tarmac sale since the year end, would be about $10.7 - if we look at what our numbers say they should close 2010 around $8.5. 

BARRY SERGEANT:  So that's coming down moderately but at least it is in the right direction.  Des just to close off with, a pure ranking for Anglo American - where would you see it relative to BHP Billiton, Xstrata, Rio Tinto and so on and how would you rate it if you are prepared to talk about that in terms of where it is in the cycle and whether or not it offers value?

DES KILALEA:  I think the premium company in the sector would be BHP Billiton.  It has got a great balance sheet, arguably it is in better geographies and then it's got much bigger exposure to iron ore and then it has got the very high margin petroleum business.  So in terms of quality I would probably say that is the premium business.  Rio Tinto has rehabilitated itself operationally and financially and it probably has less project risk than Anglo American.  I would put Anglo American in next in terms of quality alongside perhaps Xstrata - but it has got to the stage where if it can deliver Minas-Rio, if they don't shock us too many times from Minas-Rio, I think Anglo American has gone a long way to deserving a re-rating.  I don't think it's deserved just yet but it is getting there.  So we like BHP Billiton.  We think Rio Tinto is about fair and Anglo American looks about fair.

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