Anglo American's (AAL) iron ore business produces about 45 million tons per year, principally in South Africa via its 63% stake in Johannesburg-listed Kumba Iron Ore. Despite the iron ore's substantial contribution to total group revenue (21% in the 12 months to June 30, excluding operations management plans to sell), Anglo continues to view the steelmaking input as a relative gap in its portfolio. Indeed, compared with the quantities churned out by peers BHP Billiton (BLT) (109 million tons in 2009), Rio Tinto (RIO) (171 million), and Vale (VALE) (245 million), Anglo has substantially less exposure to what has become one of the world's most profitable commodity franchises. While it's highly unlikely Anglo will join the ranks of the big three anytime soon, management has big plans for growth via greenfield projects in South Africa (adding 9 million tpy) and Brazil (adding 26.5 million tpy).
While far from the largest player in the seaborne iron ore game, Anglo is a relatively low-cost producer. We estimate Kumba's cash costs at $30 per ton in 2009 and $26 in 2008 (FOB port), which would rank in the lower half of the seaborne iron ore cost curve. For reference, we estimate cash costs at industry leader Vale at $22 and $25 per ton in 2009 and 2008, respectively. Add in freight costs to China (roughly $20 per ton from South Africa and $30 per ton from Brazil) and Kumba's delivered costs compare reasonably well with the Brazilian giant's. Kumba's costs are likely to increase significantly in 2010 as the firm copes with decreasing ore grades and a stronger rand, which is on pace to gain 15% versus the US dollar. However, iron prices have risen more than enough to offset the cost inflation, following the dissolution of the annual pricing mechanism and subsequent surge in spot prices. Year to date, iron ore prices delivered to China have averaged more than $140 per ton in the spot market, making Kumba's 34 million tpy of export sales extremely profitable. The same cannot be said for Kumba's roughly 6.25 million tpy annual domestic sales, which the company has historically supplied to ArcelorMittal's (MT) South African unit at 3% above cost. In the wake of a recent controversy concerning mining rights, the enforceability of this pricing mechanism is now in some doubt. Ultimately, it seems likely that the cost plus 3% mechanism will be scrapped, replaced by a government-set mechanism that yields domestic steel prices no higher than the lowest quartile of global prices--in other words, somewhat below what Kumba might earn by selling domestic volume at the going global rate.
Whatever the future may hold for the pricing of domestic volume, Kumba's overall profitability outlook looks bright, thanks to its ability to meet growing emerging market demand in a cost-effective fashion. China will be particularly important in determining just how profitable Kumba will be: In 2009, 68% of the world's seaborne iron ore made its way to Chinese ports, up from 12% in 1999. Continued expansion of Chinese steel output would exert increasing pressure on the world's supplies of high-grade seaborne iron ore, meaning high prices and massive profits for Kumba. Kumba's near-term growth plans to meet rising emerging market demand are centered on the Kolomela greenfield project, which is on track for full production by the end of 2013. Initial capacity is slated at 9 million tpy, with cash costs expected to be in the lower half of the industry cost curve. With Kolomela on line, Kumba would have capacity of 53.5 million tpy. Additional greenfield growth opportunities (Northern Cape at 13 million tpy and Limpopo at 6 million tpy), while not yet approved, would take annual output potential to 70 million tpy.
While the Kolomela project has proceeded according to schedule and remains on budget (at a capital cost of roughly $120 per ton of annual capacity), the same cannot be said for Anglo's Minas Rio project in Brazil. Minas Rio holds tremendous promise: It's big (the project's first phase entails 26.5 million tpy capacity) and is expected to be very cost competitive once operational--management anticipates cash costs in the first quartile of the industry cost curve. But Minas Rio has been the source of many headaches. Initially, Anglo had estimated a project price tag of $2.7 billion, or roughly $102 per ton of annual capacity (excluding the billions spent to acquire the project), with mining expected to commence in 2010. But permit delays, adverse foreign exchange movements (a stronger Brazilian real), and project design changes have conspired to raise the project's cost and postpone the expected start date. In 2009, Anglo raised the estimated budget to $3.8 billion ($144 per ton) and again in 2010 to $4.6 billion ($174 per ton). Mine production is now unlikely to commence until 2013 at the earliest. While it could be argued that the escalating cost estimates aren't surprising, given the magnitude and complexity of the project (Anglo is not only building mine and beneficiation plant, but a 500-kilometer pipeline and deep-water port), this isn't Anglo's first rodeo. The company has undertaken many large, complex projects in the past and probably should have done a better job with its initial scoping.
See our analysis of Anglo American’s copper, platinum and coal operations.
