Oh, to have invested in the mining sector a year or so ago. After a dismal 2015, and dreadful start to 2016, it roared into life. Some stocks saw their share prices triple or quadruple, massively rewarding investors who were brave enough to buy at the bottom. Can this run of good fortune continue?
Rock bottom
One reason mining stocks boomed is that they were over-sold, as investors panicked in the meltdown. Another reason is that they they fought back with gusto, offloading non-core assets, paying down debt, slashing investment, cutting headcount, doing all they could to boost the bottom line, and with great success.
The result is that Anglo American (LSE: AAL) is up 126% over the last 12 months, while Rio Tinto (LSE: RIO) is up 65%. You might expect this kind of growth from a successful smaller company but it is quite remarkable coming from massive global companies with market capitalisations of £17.68bn and £45.91bn respectively.
Down with debt
Anglo-American slashed its net debt by an impressive 34% to $8.5bn in 2016 while reducing capital expenditure 37% to $2.5bn. It also boosted its attributable free cash flow by $3.5bn, giving it an inflow of $2.6bn, against a $1bn outflow in 2015. It was a remarkable turnaround, leaving the company with a much stronger balance sheet.
Chief executive Mark Cutifani has also learned his lesson: the balance sheet must be strong enough to withstand short and medium-term price volatility. Planned productivity improvements will help maintain capital and cost discipline, and help the company restore its investment-grade credit rating.
Cash is king
Rio Tinto also had a successful 2016, with strong operating cash flow of $8.5bn and underlying earnings of $5.1bn. It achieved $1.6bn of pre-tax sustainable operating cash cost improvements, and strengthened its balance sheet further with net debt reduced to $9.6bn. It still found enough cash to distribute $3.6bn to shareholders in dividends and share buybacks.
So, another impressive turnaround. Both companies were hammered by plunging resources prices, having geared up production to meet demand at a time when prices were far higher. They were also hit by fears of a crash in China, although a fresh bout of government stimulus has eased those worries for now. Much will now depend on “Trumpflation” as we wait to see whether The Donald can get his $1trn spending blitz past Congress, which could invigorate the whole global economy.
Flying metals
Global confidence is growing again and this should give both companies a further boost. However, brace yourself for further volatility. City forecasts suggest that Anglo American’s earnings per share (EPS) will soar 37% this year, then crash 26% in 2018. Rio Tinto’s EPS are set to soar 68% in 2017, then also plunge 26%.
However, trading at nine times and 14.3 times earnings, they still do not look overpriced. Also, Rio Tinto currently yields 4.06% and although Anglo-American does not currently pay a dividend, it will return. Further share price growth is possible, although do not expect either company to match its recent frenetic pace.