DBRS Confirms Anglo American at A (high), Stable Trend

DBRS has today confirmed the long-and short-term term ratings of Anglo American plc (Anglo or the Company) at A (high) and R-1 (middle), respectively, recognizing the Company’s solid business profile and strong operating results benefiting from the up cycle conditions in its core commodities. However, the Company’s net debt leverage after the acquisition of IronX (MMX) would be at the high end of the rating range. The increasing risk in the Company’s financial profile is a concern.

Anglo has a solid business profile, being one the world’s largest mining conglomerates with highly diversified operations and a leading producer in a number of its core commodities. The Company’s long life reserves provide a solid foundation for long-term growth. Anglo is making progress in its restructuring (e.g., divestiture of non-core operations) and increasing focus on the core mining activities (through its strong pipeline of projects and bolt-on acquisitions).

DBRS views these actions positively because the Company will be more focused on its core commodities and margins should improve, given the lower relative profitability of the non-core businesses. The Company also launched the “Asset Optimization Program” (AOP) in May 2007 aiming at closing the value gap between Anglo’s operations and the best in class in the industry, and, in January 2008, the “One Anglo Supply Chain” strategy (One Anglo) coordinating its spending to target a $950 million value improvement from 2011. These value enhancement initiatives bode well for increasing long-term profitability.

Benefiting from favourable conditions for most of its commodities, the Company turned in record earnings in 2007 through the first half of 2008. Most business units reported continuous improvement led by base metals, platinum and ferrous metals. Strong demand for commodities from developing countries and supply constraints supported firmer pricing, the key driver of the Company’s rising profitability. However, increases in energy and materials costs and the weakness of the U.S. dollar against the currencies of the producing regions proved to be significant challenges and limited margin improvements. The roll out of efficiency improvement initiatives, such as the AOP, has led to cost savings and productivity gains, most notably in coal, and helped partly mitigate the impact of the cost increases.

Near term, market conditions for the Company’s commodities are mixed due to negative influence from softening economic conditions in developed economies, notably the United States and Western Europe. Despite challenging conditions for nickel and zinc, strong fundamentals in iron ore and coal are expected to support the record pace in profit at Anglo. The long-term outlook for Anglo’s core commodities is favourable. The ongoing urbanization and industrialization of the developing countries, particularly China, is expected to support the long-term demand growth for commodities. Furthermore, inefficient infrastructure, a lack of skilled labour, energy shortage/disruptions in key producing regions, long lead time to bring on new supply, etc., would continue to constrain supply. The demand/supply imbalance would likely keep supporting higher commodity prices in the medium term. Additionally, the Company has an attractive portfolio of growth projects ($15 billion approved to date) which should materially add to its production capacity. The Company is also active in strengthening the market position of its core commodities with bolt-on acquisitions adding to growth potential.

Anglo is well positioned to benefit from the current growth trend in commodities. However, rising input costs, especially in energy, materials and labour, are expected to remain substantial, limiting margin improvement. Full implementation of the profit enhancement initiatives, such as the AOP and the One Anglo programs, is expected to boost efficiency but savings from these actions would only partly mitigate the cost increases.

The Company has been active in acquisitions and share buybacks and has used debt to partly finance these transactions. Debt levels have been rising, and gross leverage (gross debt/total capitalization) was above 27% (19% on a net basis) at the end of June 2008, up from below 21% at the end of 2006 (12% on a net basis). The Company’s financial profile, albeit weakened, is still acceptable for the ratings. Moreover, all debt coverage ratios remained very strong despite the higher debt levels, which provided further support. However, pending transactions could weaken the Company’s financial profile. (1) The Company has committed to spend about $5.5 billion in a two step take over of MMX which would raise net leverage to near 35%, on a pro-forma basis, an aggressive level for a highly cyclical mining company. (2) The Company has only completed 35% of a $4 billion share buy program announced in August 2007, and completing the program will cost approximately $2.6 billion. Buying back shares, if financed with debt, would further weaken the Company’s financial profile. (3) The Company has approved a large capital expenditure program, totalling $15 billion, for the next few years. Although DBRS expects the Company to be able to fund these projects from internal cash generation, any unexpected weakness in earnings and associated cash flow could add to the Company’s funding pressure. (4) Weak market conditions have caused the Company to delay the divestiture of Tarmac, the industrial materials business. Postponing the sale of Tarmac has increased the risk of more borrowings to fund the Company’s various capital needs.

The main risk to the current ratings is the rising net debt leverage. Near term, DBRS expects that funding the acquisition of MMX would lead to an increase in net debt, and the resultant higher leverage would be aggressive for the ratings. DBRS notes that the Company’s weakened financial risk profile would still be acceptable for the ratings supported by strong earnings, cash flow and debt coverage ratios. However, with substantial cash needs to fund the share buy backs and the large capital expenditures in the next few years, the Company is vulnerable to any unexpected down turns in the commodity markets.

Deleveraging the balance sheet with free cash flow and proceeds from asset sales would be paramount. A lack of progress in reducing the net debt leverage to near current levels by the end of 2009 and/or a sharp deterioration in the debt coverage ratios due to the higher debt levels and/or weaker earnings could lead to negative rating actions. Longer-term challenges facing the Company include bringing the expansion projects on stream, on time and on budget. Rising input costs and skilled labour shortage are also major headwinds to sustaining profit momentum.

Notes:
All figures are in U.S. dollars unless otherwise noted.