Less Debt Becomes A Valuable Commodity


Image source: AngloAmerican

What's going on?

In another sign of the mining industry’s recovery, London-based global miner Anglo American had its credit rating upgraded on Friday – indicating that it is now at a much lower risk of bankruptcy than in previous years.

What does this mean?

Just like people, companies have credit ratings too. On Friday, S&P (a major credit rating agency) said Anglo American once again qualified for an “investment grade” (IG) rating. It had been demoted to sub-IG in February 2016 when commodity prices (like iron ore) were at their lowest level and Anglo American’s heavy debt load made it more vulnerable to bankruptcy (partly because it couldn’t sell its products for as much money, endangering its ability to pay back its debt). The distinction between IG and sub-IG grades is an important one, because many investment funds don’t like to buy bonds of sub-IG companies – they are often deemed too risky.

Why should I care?

The bigger picture: Hunkering down to survive is a viable strategy during a crisis.

During the commodity price meltdown, Anglo American took drastic action to reign in costs and sell off some of its mines that weren’t essential, which reduced its debt. The subsequent big rebound in commodity prices, driven largely by the Chinese economic recovery, also played a big role in its recovery – Anglo American is now in a much safer position than it was just 18 months ago.

For markets: Mining stocks have recovered spectacularly – but the ending could have been much different.

It’s risky to own stock in a company with a heavy debt load because, in the event of a bankruptcy, those that have lent the company money (e.g. bondholders) get to take control of the company – and shareholders are usually left with nothing. When a crisis hits a heavily indebted industry, as it did in mining in 2015-2016 and banking in 2008, stock prices tend to drop sharply to reflect the higher risk of bankruptcy. When that risk lessens, the returns to shareholders can be massive: Anglo American’s stock price is now more than five times its low.

Originally posted as part of the Finimize daily email.

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