Financial Mail - Investors Monthly - - Analysis: Resources Funds -

Coro­na­tion Re­sources Fund co-manager Nic Stein says the fund has been an­chored by three large hold­ings in An­glo Amer­i­can, Sa­sol and Exxaro.

As far as An­glo Amer­i­can goes, Stein says: “We like the un­der­ly­ing com­mod­ity mix, par­tic­u­larly di­a­monds, cop­per and plat­inum. Di­a­monds (through De Beers), though soft, are hold­ing up bet­ter than most re­sources. There have been no ma­jor dis­cov­er­ies in the past 15 years. So sup­ply has been con­strained, while de­mand has been sup­port­ive from the likes of China and Amer­ica. It is a late cy­cle com­mod­ity and should ben­e­fit from China’s at­tempts to shift to a more con­sump­tion-based econ­omy.”

One of An­glo’s big as­sets is the Mi­nas Rio iron ore project in Brazil, which is in ramp-up. “The high iron ore price over the past decade has [en­cour­aged] the new pro­duc­tion,” says Stein. An­glo has im­paired most of the value of Mi­nas Rio since it ac­quired it in 2008. Im­prov­ing cap­i­tal al­lo­ca­tion de­ci­sions, as well as ad­dress­ing a cost base which is not as lean as its peers, pro­vides the com­pany with some “self-help op­por­tu­ni­ties” to grow earn­ings and im­prove re­turns on cap­i­tal.

But the at­trac­tion of An­glo is also one based on value. “From a price:book ra­tio per­spec­tive, at the cur­rent share price, you are get­ting it at the cheap­est level we have seen in 30 years. It trades on 8,5 times our as­sess­ment of nor­malised earn­ings, which is at­trac­tive.”

Has China’s slow­down sur­prised in­vestors? “I think it’s a case of the whiplash ef­fect,” says Stein. “The high lev­els of GDP growth we have seen in the past decade were built on a plat­form of in­cred­i­bly high fixed cap­i­tal in­vest­ment. This has cre­ated a high base, and as the econ­omy changes, this will have huge ram­i­fi­ca­tions for com­mod­ity mar­kets — where China ac­counts for as much as 70% of de­mand.”

In terms of Exxaro, Stein is im­pressed by the com­pany’s ther­mal coal as­sets. “We think it’s an un­der­ap­pre­ci­ated, scal­able re­source they have in the form of the Grootegeluk coal mine, and the con­tract to sup­ply Eskom makes the re­turns for this as­set ‘bond-like’,” he says.

Exxaro’s min­eral sands busi­ness (Tronox) op­er­ates in a mar­ket that is more opaque. But the sub­sidiary has $9,8bn in as­sessed taxed losses. “So there is plenty of merger and ac­qui­si­tion po­ten­tial. On the cur­rent Exxaro price, you are get­ting Exxaro’s stake in Kumba for free. In ad­di­tion, it trades on a low mul­ti­ple on our as­sess­ment of nor­malised earn­ings, so it’s a de­fen­sive al­lo­ca­tion to make in the port­fo­lio,” says Stein.

There is plenty of room for some smaller com­pa­nies in the port­fo­lio too. One of th­ese is Mer­afe, which op­er­ates a joint ven­ture with Glen­core on a fleet of fer­rochrome smelters. “It was largely the price that at­tracted us,” says Stein. “There is limited sup­ply com­ing on stream af­ter the ramp­ing up of the Lion 2 project. The com­pany has taken share­holder-friendly de­ci­sions, such as shrink­ing the head of­fice and re­sum­ing div­i­dend pay­ments. Hav­ing a size­able com­mer­cial share­holder in Glen­core also pro­vides com­fort.”

There are al­ways a num­ber of ways to reach a con­clu­sion on the val­u­a­tion of a com­pany, as Stein demon­strates. “We be­lieve Glen­core’s as­sess­ment of fair value is far above where the share price is now, so any price weak­ness may well lead to them step­ping in as buy­ers, lim­it­ing the down­side. Look­ing at it an­other way, if you had to re­place the smelters the com­pany owns to­mor­row, the cost would be equiv­a­lent to R2,50/share” says Stein. Mer­afe’s cur­rent share price is 91c/share.

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