Dear Valued Visitor,

We have noticed that you are using an ad blocker software.

Although advertisements on the web pages may degrade your experience, our business certainly depends on them and we can only keep providing you high-quality research based articles as long as we can display ads on our pages.

To view this article, you can disable your ad blocker and refresh this page or simply login.

We only allow registered users to use ad blockers. You can sign up for free by clicking here or you can login if you are already a member.

BHP Billiton Limited (ADR) (BHP), Rio Tinto plc (ADR) (RIO): This Miner’s Margins Might Soar

Anglo American (NASDAQOTH:AAUKY.PK), which is down by more than 30% year-to-date , has hugely underperformed its peer miners BHP Billiton Limited (ADR) (NYSE:BHP) and Rio Tinto plc (ADR) (NYSE:RIO). Anglo’s stock underperformance can be explained through its weak operational results. Despite being very concentrated in iron ore production, the underperformance has not been related to the metal’s weak prices. Anglo’s CEO Mr Cutifani, has now committed himself to aggressive profitability targets. I think he might achieve its targets helping the stock outperform its peer group going forward.

BHP Billiton Limited (ADR) (NYSE:BHP)

Costs must fall

Anglo’s management has simply been a lousy resource allocator, making the company the least profitable in the large diversified mining group over the last five years. While Anglo American has shown 8% returns on capital employed, BHP Billiton Limited (ADR) (NYSE:BHP) and Rio Tinto plc (ADR) (NYSE:RIO) have achieved returns of 15% and 20%, respectively. Anglo’s new profitability target has been set at 15% for 2016. Mr. Cutifani doesn’t plan to rely on higher commodity prices. He aims to cut costs and improve the profitability profile of its large capital expenditure (CapEx) program.

The bar has been set high. A 15% return would mean an improvement in cash flows of about $3.5 billion. At least $1.3 billion will come from overhead savings, trimming logistics costs and a better sales performance, but the rest will need to come from other sources such as CapEx.  As a matter of fact, 2013 CapEx was reduced from $7.5 billion to $6.5 billion, making the gap narrower by $1 billion. Since dividends will not be touched (the yield is now at an attractive 4%), the remaining amount will surely come from CapEx too.

Valuation and ongoing risks

Anglo American trades at 2013 15 times P/E while BHP Billiton Limited (ADR) (NYSE:BHP) and Rio Tinto plc (ADR) (NYSE:RIO) trade at 13 times and 10 times P/E, respectively. You may think that Anglo American is considerably more expensive than its peers but multiples are a static valuation short-cut. If Anglo’s plans work as expected, earnings should grow considerably and the company’s multiple will fall accordingly.

You may also argue that Anglo American is a riskier play than BHP Billiton Limited (ADR) (NYSE:BHP) and Rio Tinto plc (ADR) (NYSE:RIO) given Anglo’s dependence on iron ore, its exposure to the risk of labor unrest in South Africa (where Anglo makes 46% of its cash flows) and its higher net debt to EBITDA multiple.

DOWNLOAD FREE REPORT: Warren Buffett's Best Stock Picks

Let Warren Buffett, George Soros, Steve Cohen, and Daniel Loeb WORK FOR YOU.

If you want to beat the low cost index funds by 19 percentage points per year, look no further than our monthly newsletter.In this free report you can find an in-depth analysis of the performance of Warren Buffett's entire historical stock picks. We uncovered Warren Buffett's Best Stock Picks and a way to for Buffett to improve his returns by more than 4 percentage points per year.

Bonus Biotech Stock Pick: You can also find a detailed bonus biotech stock pick that we expect to return more than 50% within 12 months.
Subscribe me to Insider Monkey's Free Daily Newsletter
This is a FREE report from Insider Monkey. Credit Card is NOT required.