Description

Anglogold Ashanti

AngloGold’s stock has almost doubled in the past  6 months, based on market hopes of a makeover under its new CEO, Kelvin Dushnisky. Expectations are high that the new CEO will be able to extract great value by swapping a range of assets with his ex-colleagues at Barrick, finally dispose of the last mines in South Africa, redomicile the group outside South Africa and builld a growing global gold miner with critical mass.

While one must be careful not to underestimate a gifted CEO with the ability to issue highly rated stock, we believe that the task is likely to be more challenging than the market believes. With the exception of the group’s 45% stake in Kibali, all the existing assets are either in the wrong half of the Cost Curve, or lack critical mass or have mine lives of less than 5 years. This is hard to reconcile with a premium rating.

Our Sum of the Parts values Anglogold at between $2.85 and $5.60, depending on whether one shares management’s optimism on the revival of the Obuasi mine in Ghana. We subscribe to Randgold’s view on Obuasi, that it’s worth zero. On that basis the group should be valued at $2.93bn, compared to the current TEV of $7.087bn. With the shares trading at $12.85, the premium could unravel very quickly. SELL.

Background

Anglogold is a South African registered company that used to be called Vaal Reefs. It was a blue chip gold share since the late 1940’s, paying reliable dividends and providing handsome capital growth during gold bull markets. The group eventually absorbed all Anglo American’s gold mines by way of a share swap in 1998, when it changed its name to Anglogold. All the liabilities of the Anglo gold mines dating as far back as the 1890’s such as the recent occupational lung disease class action and other environmental risks are therefore present in the listed vehicle and cannot be expunged or de-merged until the group can restructure itself.

Likewise, the group’s South African domicile means that the South African Reserve Bank has a final say over corporate restructurings, such as the blocked demerger plan of 5 years ago. It also means that exchange control provisions stand in the way of running an efficient treasury process to nett off gross cash. It further means that this increasingly international company  has to comply with South African Black Economic Empowerment and affirmative action laws and codes, that at its most benign level diverts management focus from the job of growing shareholder value.

The current portfolio

Under previous management,  Anglogold often attempted to buy cheap assets and sold quality. The result is that production fell from 7.0m ozs in 2001 to 5.5m ozs in 2007 to an estimated 3.3m ozs last year. The production acquired during the merger with Ashanti Gold fields of 1.6m ozs in 2003 should  be added to these figures.

At present Ore Reserves and production rates, the group’s portfolio looks as follows.

As can be seen, none of the assets bar Kibali are structurally first-tier assets if one sets the fairly undemanding hurdles at the bottom of the table. And even Kibali being situated in the DRC cannot be regarded as comparable to similar assets in the the US, Canada or Australia.

Some of the mines’ US Dollar denominated costs have recently been assisted by currency weakness, especially Cerro Vanguardia in Argentina where the Peso has halved in the past year and to a lesser extent the Australian, South African and Brazilian operations.

We derived the following SOTP valuation, using a gold price of $1300/oz and a real discount rate of 8%.

While the individual mines are uninspiring, the group delivers critical mass to investors and as such has some cachet for its tradability and option value. The problem is that this optionality decays as the mines eventually shut down. The extent of this decay caused the previous CEO, Venkat, to devise a concept called the Preferred Scenario, whereby vast swathes of ore resources would miraculously be converted into Ore Reserves, prolonging the lives of the mines.. The extent of the problem and the implausibility of the Preferred Scenario can clearly be seen on the following graph.

As if the dwindling Ore Reserves are not enough, the group’s cash flows have also disappointed for the past  10 years.

With Anglogold committing $545m to Obuasi commencing in Q4 last year, this dismal cash flow trend is unlikely to improve any time soon.

We are extremely negative on Obuasi. Having visited the mine some years ago, it was clear that an entirely new mine had to be built, while at the same time the legacy environmental liabilities were daunting. The new mine plan that is currently being rolled out contains several unrealistic assumptions that have all the makings of a classic “mission creep” . We therefore see the first $545m that is budgeted to be spent between Q4 last year and end-2020, as mere “gate money”. After that, we fully expect management to attempt to justify spending at least a further $500m merely to give the mine a fighting chance.  It would be a tragedy if the new CEO sold the stake in Kibali and spent the money on Obuasi.

So while there are clearly still gold bulls in the world who allocate funds to the sector on a top down basis, we believe that Anglogold is unlikely to outperform its peers any time soon. The recent rally therefore presents an interesting opportunity to short the stock on a pair trade.against the likes of Barrick.

Catalyst

Short term catalysts :

AngloGold’s suite of Annual Reports, including the Annual Reserve and Resource Statement, will be released at the end of March. This may contain a significant reduction of the Ore Reserves to more accurately reflect reality at mines like Mponeng, Obuasi and Mine Waste Solutions.