Dr John Lynch: Investing in lucrative mining is not always seamless
Published 03/03/2014 | 02:30
There are a couple of reasons why I'm nervous about investing in the mining sector.
The first is the experience of the mining industry in Ireland. There was a time, shortly after the first discovery in the early 1970s of what turned out to be the world-class lead-zinc ore body in Navan, Co Meath, that Ireland was being promoted as Europe's great new mining province.
I knew someone in the IDA at the time who boasted that the largest file he had was devoted to the establishment of a zinc smelter in the Shannon estuary. The smelter never happened, nor did the great wealth that was promised.
The other good reason for not trusting the sector was the sage warning from Mark Twain, who proclaimed that "a mine is a large hole in the ground with a fool at the bottom and a liar at the top".
For both of these reasons I have been agonising over a possible investment in one of the gold mining world-beaters, the company known as Anglo American. The company has been going through some strategic changes and it might just be a good time to be on board.
Anglo American tells much of the story of 20th Century mining and much of the story of South Africa, too. It was the product of a fundraising by the Wall Street giant JP Morgan to develop a gold mine in South Africa.
The company was called Anglo American because Britain and the US were where the cash came from. But the big influence was the family of Ernest Oppenheim who for decades were involved in the lucrative South African gold and diamond sectors.
Wherever there was a large hole in the African continent, mining precious or base metals or coal, Anglo American wasn't far away. So much so that today it is quoted on the London Stock Exchange and ranks number 27 in the FTSE100 with a value of £21bn (€25.5bn).
It was its merger with Minorco in 1999 that forms the basis of Anglo American today with five core business units like copper, coal, De Beers diamonds, iron ore and platinum. The company also has a global footprint, with operations in 45 countries and over 100,000 employees.
Recently Anglo American has not been a happy camp. Often the market wakes up to the fact mining is risky. Large sums invested today may not make a return for a decade.
In addition, the dependence of China on minerals and other natural resources is not as impressive as it had been for the past decade.
The mining giant has two significant worries in different parts of the world. One is its failure to tackle the massive cost overruns in its Brazilian iron ore project and, secondly, the problems in its South African platinum business. Platinum miners are striking over wages.
Anglo American's problems lie in its high cost, labour intensive, deep mines. Its turnaround strategy calls for mechanised open-pit mining. But this strategy could have significant knock-on effects on the political and economic situation in South Africa. As Anglo American had 70pc of its earnings last year in South Africa, this strategy needs to be carefully managed.
In the midst of its difficulties Anglo American may have to fight off a bid. Five years ago, Xstrana proposed and abandoned a $30bn offer. Since then, Xstrana has been gobbled up by Glencore, which has now become the most often mentioned potential bidder for the company.
The Anglo American strategy is working as the company posted a strong set of results for last year. Operating profits rose 6pc, to $6.6bn. Its shares this year have outperformed the mining sector.
However, to keep investor confidence a solution to the platinum mines in South Africa and smooth operations of the Brazilian ore mine would be extremely helpful. As would a reduction in its capital expenditure, given its high net debt.
The shares at £15.31 have retreated from its high last year of £19 and trade on a price-to-earnings ratio of 16. The problem of investing in Anglo American is the shares appear to be fully valued, but then there is always the takeover rumour to consider. However, always remember the Mark Twain quote.
NOTHING PUBLISHED IN THIS SECTION SHOULD BE TAKEN AS A RECOMMENDATION, EITHER IMPLICIT OR EXPLICIT, TO BUY OR SELL ANY OF THE SHARES MENTIONED