Valuation: Anglo American (LON:AAL) 23H1

I revisit my AAL valuation following their 1st half 2023 results publication. Now that 2023 is over, with the benefit of hindsight, which assumptions did I get wrong?

I first published this in September 2023 on the Trading 212 app in the Value Investing community under the username “Anathema”.

3 months ago, LON:AAL was trading at £23 and I was bullish, based on FY22 results. I placed a fair value of £30 on the stock, even factoring in significant reductions in diamonds and corrections in coal and iron ore prices.

As @PositionHunter posted from Brian Feroldi's Investing Lessons, it's emotionally harder to remain confident when your share price is dropping. AAL is now closer to £20 and has published its H1 results. So, was I wrong?

Short answer must be "yes," but what did I overlook, and can I still stand behind my valuation?

Revenues and Earnings

On a TTM basis, revenues across major segments are around 20% down y/y, 10% down h/h. In terms of contribution, there has been a 400 bps shift from PGM to Copper, both of which are running at around 13% margin. But earnings have dropped far more than 10%, they are more like 33% down. Compared to FY22, margins are around a third lower in 23H1 for each of De Beers, Nickel, PGM and coal, which collectively make up around 2/3rds of AAL's earnings - meaning a loss of over 20% of last year's earnings from these sectors alone.

However, I had roughly expected this, as copper, PGM and coal were all obviously trading above long-term average prices last year. I had also excluded De Beers contributions from my previous valuation to try and allow for a shift to lab grown diamonds in the future (even though De Beers have a presence in this market via Lightbox).

The severe drop in earnings has pushed 5y CAGR for revenue, EBITDA and EBIT into single digits and has pushed EPS 5Y CAGR into negative territory. However, dividend growth is still strong, having more than doubled in 5 years.

Balance Sheet and operational effectiveness

The balance sheet remains strong, but AAL did take out more debt in the last half and increased the amount of working capital. Coupled with the reduction in gross, EBIT and net profit margins, this has reduced ROA, ROIC, ROCE and ROE by between 30% and 50%, depending on the specific metric and adjustments being reviewed. Critically for me, several of these metrics are now below 10%, a bit of a benchmark I have for myself.

WACC is slightly improved, down from near 10% to around 8.3%, and inventory turns are up, but the primary reason for the reduction in cash conversion cycle is a fairly hefty increase in equivalent payable days, up from 31 days to 55 days. Not paying your suppliers is a warning sign for me, but given the high values for quick and current ratio, in this case, I'm not worried yet.

Valuation

If I reset my assumptions to match the current TTM of EPS of around £1.70, and assume a further 30% drop is possible (PGM still accounts for a quarter of earnings), with a maximum annual growth rate of 5%, assume WACC is between 8% and 12%, terminal P/E of between 5 and 10 and risk-free rate of between 2% and 4%, I estimate a P80 value of around £27 and a P50 value of around £29.

BUT - this range assumes a tangible book value of £15 to £20. I feel it is appropriate to include the book value in the share price valuation as liquidation would genuinely release some value. But I know not everyone includes this contribution and, due to the strength of the balance sheet, it is a significant contributor in this case.

If I disregard the book value, I get P80 values around £9 - £10 and P50 of £11 - £12.

This implies to me that the market is either considering some residual asset value, but maybe not as much as me, or is assuming higher growth than my pessimistic growth assumptions above.

Conclusion

I may continue to be proved wrong, but I still feel a value around £30 is justified. It is true that continued weakness in commodity prices and reduction in PGM contribution could bring my valuation down, but I am standing behind a price target of around £30 for now. However, the low rates of return now being experienced mean I may not add to my holding at the moment.