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Morningstar | Long-Term Assumptions for Anglo American Reviewed and FVE Retained

We’ve reviewed our long-term assumptions for no-moat-rated Anglo American after a recent investor update. We retain our GBX 1,150 per share fair value estimate with the positives and negatives offsetting each other. The several positive changes include the proposed expansion of the Collahuasi copper mine, stronger volume guidance for diamonds and coking coal, a reduction in our forecasts for platinum costs and the lower GBP/USD exchange rate. However, the negatives were lower forecast volumes for platinum and thermal coal, an increase in our operating cost forecasts for iron ore, copper and nickel and higher long-term capital expenditure. We’ve also incorporated the approval for Anglo’s 60% owned Quellaveco copper mine which, by itself, is modestly dilutive to our fair value estimate.

Anglo’s shares remain overvalued. We expect future free cash flow to decline as prices for key commodities, such as coking coal, thermal coal and copper, fall in future as consumption from China slows.

On a 100% basis, Quellaveco is expected to produce about 300,000 tonnes of copper a year for the first 10 years, and an average of 240,000 tonnes a year over its entire 30-year reserve life. For our base case, assuming a midcycle copper price forecast of USD 2.30 per pound, we estimate Quellaveco detracts from our fair value estimate by GBX 40 per share. The capital cost for 100% is estimated at USD 5.0 to 5.3 billion and cash costs, excluding royalties and maintenance capital expenditure, at USD 1.05 per pound for the first 10 years and USD 1.24/lb for the 30-year reserve life.

Quellaveco requires significant capital expenditure with Anglo’s share at USD 2.6 billion. The expenditure brings additional leverage to commodity prices for Anglo American, though not enough to change our very high fair value uncertainty rating. In our bull case scenario, assuming midcycle copper of USD 2.70 per pound in 2021, we estimate Quellaveco would add GBX 80 per share to our fair value estimate.

Anglo American remains focused on cost efficiencies and productivity. The company is looking to employ a range of innovative technologies to improve mining, hauling and processing efficiencies. The efforts should reduce the amount of energy and water needed to process ore, as well as screen out a greater proportion of waste rock earlier in the cycle. However, we see a number of similar productivity initiatives being undertaken by Anglo’s key competitors. Overall, we collectively see these initiatives as part of the ongoing technological gains which should help to boost production and lower costs for the industry. We think the competitive nature of the mining industry will likely mean much of the benefits from new technology will be passed on to customers in the form of lower commodity prices, enabled by a lower cost curve.

Anglo’s expectations for increased capital expenditure reflect a growing focus on growth. We are also seeing this with Anglo’s peers, such as Vale, a natural evolution as the commodity price cycle matures. If prices stay higher than we expect in the medium term, it’s likely the industry will start to meaningfully increase its expenditure on exploration, the development of new mines and potentially acquisitions. This would likely impinge on medium-term free cash flows and the market’s view of long-term valuation.