If Anglo American doesn’t want to keep Kumba Iron Ore, why should any other investors want it?
At Kumba’s interim results presentation last week, outgoing CEO Norman Mbazima reiterated the reasons Anglo American CEO Mark Cutifani had previously given for selling Kumba, which related to the nature of the assets and the long-term fundamentals for iron ore.
Mbazima said Anglo American sold assets responsibly, ensuring they could stand on their own feet outside the Anglo group. It was impossible to say yet what the effect on Kumba’s cost base would be if it no longer shared certain service costs with Anglo American.
Despite the surge in iron ore prices in the first half of this year, market consensus on the outlook is negative, and Mbazima admitted that "supply-demand fundamentals remain challenging".
Global supply will be boosted by three major projects that are ramping up: Anglo’s own Minas-Rio in Brazil; the new Roy Hill mine in Australia; and Vale’s S11D mine. Mbazima said the recent increase in prices was likely to encourage the return of mothballed production to the market.
At the same time, the recent surge in iron ore demand is expected to start tapering off.
Momentum SP Reid Securities analyst Percy Takunda says in a recent note on Kumba: "The real challenge for the iron ore market is that Chinese demand is not supporting current production for one reason or another (slowing growth, lower stimulus provision, problems with provincial parastatal funding, working capital constraints on traders etc)."
He says: "There is more risk of the Kumba price correcting downwards than [of it moving] upwards. Notwithstanding the potential for a functional mine plan at Sishen, we believe the correlation risk with a downward correction in the iron ore price warrants us to downgrade our recommendation to ‘sell’."
Foreign buyers of Kumba are unlikely to be plentiful, given the current regulatory uncertainty affecting mining companies in SA, militant labour and the rising costs of power.
The only local entities that could raise R29bn to buy Anglo’s stake in Kumba would be part of government, such as the Industrial Development Corp or the Public Investment Corp, with the aim of sustaining SA’s struggling steel industry.
In the absence of those buyers, Anglo American might unbundle its stake in Kumba, but that would not raise the funds that Anglo needs.
Kumba is not a burden to Anglo, particularly as it is now debt free.
It held net cash of R548m at end June compared with net debt of R6.1bn a year ago.
Kumba has other attractive aspects. It has taken the necessary action to survive in a low-price environment. Mbazima says it can break even at a price of US$32/t-$40/t.
UBS Group is forecasting $47/t next year.
Kumba has cut its workforce by a third in the past year, which will deliver cost savings in future years. The interim dividend was passed; CFO Frikkie Kotzee says if it had paid one, Kumba would have had to resort to debt. But it will pay a dividend when it has excess cash.
In a market weighed by surplus iron ore, Kumba’s growth is centred largely on low-cost, incremental expansions, and it has no large commitments.
It is continuing to explore for additional resources in the Northern Cape.
Abdul Davids, head of research at Kagiso Asset Management, says one of Kumba’s long-term attractions is that it produces a signification portion of lumpy ore, which commands a premium in the market.
"Kumba is debt-free and, with the restructured Sishen operations and lay-offs, the cost base is substantially lower. There is a concern that Kumba will need to invest in its mines to sustain current levels of costs and therefore it might be too early to focus on dividends.
"Kumba could remain a viable, profitable company if it continues with its cost rationalisation programme and the maximising of cash flows, albeit with a smaller production footprint and shorter life of mine."
Kumba’s shares trebled in the first half of this year, tracking iron ore prices and the rest of the commodities sector, on hopes that China’s stimulus policies would revive the flagging economy. But even at R130, Kumba is at less than half its level of 18 months ago and about 25% of its early 2013 peak.
The shares will certainly fall as iron prices track downwards, but investors who want iron ore in a diversified resources portfolio and are prepared to wait out the cycle could buy the shares on dips of between R50 and R100.