A Dividend Cut & Rights Issue May Be On The Cards For Anglo American plc

2015 has been a year shareholders of Anglo American (LSE: AAL) would rather forget. Year-to-date the company’s shares have fallen a staggering 69%, excluding dividends. Including dividends the company’s shares have returned -66%, which is hardly any consolation. 

And there could be further pain ahead for Anglo’s investors as it’s widely expected that the company will announce a dividend cut this week. What’s more, if the most pessimistic City analysts are to be believed, Anglo will require a rights issue to reduce its debt to sustainable levels.

A big mistake 

Anglo’s troubles can be traced to the company’s ill-fated expansion into the iron ore industry.

 The company is the majority owner of Kumba Iron Ore Ltd., Africa’s largest iron ore producer. It also owns a key operation in Brazil, the troubled Minas-Rio asset, which went into production last October, about five years late and almost three times over its original $2.6bn budget.

Anglo’s South African iron ore operation, Kumba needs to sell its iron ore at a price of $50 per tonne or more to remain profitable. Unfortunately, the spot price of iron ore slumped to an all-time low of $39.40 a tonne last week, and there’s nothing to indicate that the price of iron ore will recover anytime soon. Indeed, according to investment bank Morgan Stanley, the iron ore market will peak at 107.4 million tonnes in 2018 and persist through to 2020. 

But Anglo doesn’t seem to care. The company is planning to increase iron ore production from 11m tonnes per annum this year, to 29m per annum in the 2018-2020 period. Dumping more iron ore on a market that’s clearly oversupplied isn’t the best strategy, and if iron ore prices drop further, Anglo is set to lose billions pursuing this strategy. 

Debt mountain 

One of the key priorities for Anglo’s management going forward is the reduction of the group’s debt pile. Anglo has net debt of $11.9bn more than its current market capitalisation of £5.1bn. The company is seeking to raise $3bn by selling non-core assets and cutting jobs to trim costs. By offloading its tarmac business, two copper mines and three gold mines the company has been able to raise just under $2.5bn, without these sales net debt would have exceeded $14bn. 

Anglo has a long-term net debt target of $10bn to $12bn and with profits falling, even after including the cash raised from asset sales, the group is running out of options to pay down its debt pile. City analysts believe that the company could save $1.1bn per annum if it suspends its dividend, which might be the most prudent action for management to take.

The market seems to believe that the company will follow this course of action. Anglo’s rolling dividend yield has recently surged to a staggering 15%. A good rule-of-thumb is to treat any dividend yield more than twice the FTSE 100 average with a bit of scepticism. Today that means that investors should consider avoiding stocks with a dividend yield of more than 8%.