Iron ore crash sends Kumba from darling to reject

Johannesburg - Less than four years ago, Anglo American [JSE:AGL] increased its controlling stake in Kumba Iron Ore [JSE:KIO] by 4.5% for almost $1bn. Now, its entire stake is valued at less than that.

Kumba became the latest casualty of iron ore’s price slump as Anglo seeks to dispose of its 69.7% interest in Africa’s largest producer of the steelmaking ingredient, an investment that accounted for half the London-based company’s profits three years ago.

READ: Anglo - the great iron ore flood's biggest victim

While the price of iron ore dropped by more than three-quarters since its peak in 2011 as the largest producers including Rio Tinto and BHP Billiton [JSE:BIL] fuelled a glut, Kumba had to cut its workforce by a third and axe a dividend that Anglo depended on since the Pretoria-based company’s listing in 2006.

“It was a big contributor to Anglo,” Norman Mackechnie, a fund manager at Momentum Asset Management, who helps to oversee more than $20bn of investments that include Anglo and Kumba stock, said by phone on Tuesday. “Unfortunately people’s minds were clouded and didn’t pay attention enough to the oversupply that was coming through - we’ve seen this movie before.”

In 2002, Anglo bought a 20.1% stake for the equivalent of $220m in Kumba Resources, a company that controlled the Sishen mine, the world’s third-largest iron ore operation at the time. It took control of the company in 2003 in a series of deals that raised Anglo’s holding to 66.6%.

The producer relisted Sishen in a new company three years later while merging Kumba’s coal and zinc assets to create Exxaro Resources [JSE:EXX] in a venture with Eyesizwe Coal.

Market value

“We realised Anglo’s major objective was to get to the iron ore because that was a commodity that was humming at the time,” Con Fauconnier, the chief executive officer of Kumba Resources until November 2006, said by phone on Tuesday. “Sishen is a fantastic asset. The ore is very sought after because it is some of the hardest in the world,” which means it makes stronger steel.

After the listing in November 2006, Kumba’s market value surged more than fivefold to about R180bn in February 2013 as growth in China, the biggest consumer, fuelled demand. It has paid $5.6bn in dividends to Anglo and accounted for 49% of the parent’s underlying earnings in the first half of 2013, analysts at Citigroup wrote in a note to clients on Tuesday.

READ: Anglo to exit Kumba as profits plunge

In 2012, Anglo again increased its holding in Kumba to the current size, paying $948m for a 4.5% stake. In the same year, it opened the Kolomela pit, a $1bn investment that Anglo flagged as one of its key projects at the time.

These investments reflected Anglo’s view “on the quality of the business and its highly attractive performance and growth profile”, former CEO Cynthia Carroll said in July 2012.

After iron ore prices reversed as a result of a global oversupply and China’s reduced demand for the commodity, Kumba saw its fortunes change. Profits last year fell more than two-thirds from 2012 while it dropped its dividend for the first time in 2015. The company is busy cutting more than 3 900 jobs, or about a third of its workforce, in an effort to remain profitable.

Anglo’s options

Anglo will either spin off or sell its stake in Kumba and hopes to complete a deal before the end of 2017, the parent’s chief financial officer, Rene Medori, said on a call with reporters on Tuesday. At the current share price of about R57, Anglo could raise $780m if it sells it stake, the Citi analysts said.

“Who wants to buy a higher-cost producer unless you get it very cheaply,” Momentum’s Mackechnie said. “Whoever buys those assets needs to take a view on what iron ore will do over the longer term. No one can answer that question, it will all be guesswork.”

Kumba shares rose 0.9% to R58.50 on Wednesday, giving the company a market value of about $1.19bn.

Anglo’s divestment could be beneficial for Kumba’s minority shareholders because it will make the stock easier to trade as it’s more readily available, Citi’s analysts said.

“Historically it has not been unusual for the big diversified miners to sell assets near the bottom of the cycle,” they said. “In the event of a spin-out, Kumba’s shares would be materially more liquid over time.”

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