Research Portal

Some research on Glencore PLC.

/

We’ve identified a piece of research compiled by one of our sister companies (GT Private Broking) on Glencore, that might be of value to our EasyEquities investors. Traditionally GT Private Broking provides products and services to sophisticated investors, so this piece of research is not necessarily suited to all, but we believe it could still be beneficial to some #Easy investors. Enjoy and #HappyInvesting.

Mining    
Glencore     
Share price: 95 pence  
Share in issue: 14 586 million   
Market cap: £13,8 billion  
Fair value: a bumping along the bottom scenario indicates 70 pence with a low road scenario on 180 pence
Target price: 200 pence on a realistic through the cycle view   
Trading Buy and Portfolio Buy

Glencore is being priced below the spot price of its commodity basket. This basket comprises of a number of commodities that Glencore deals in i.e. Copper, Zinc, Nickel, Iron Ore etc. Glencore is currently trading at a lower price than the spot price of this basket of commodities.

One of the biggest shortcomings of Glencore is that it has high levels of debt for a miner. With less debt we would probably not see the extreme volatility in the share price. Glencore has a high delta, which means that a change in the underlying assets/commodities (Copper, Zinc, Nickel etc) has a huge impact on the change in the share price of Glencore; i.e it is extremely sensitive to movements in price of the underlying commodities. EBITDA (earnings before Interest, Tax, Depreciation and Amortisation) provides a way to evaluate a company’s performance without having to factor in financing decisions, tax environment or accounting decisions. So, it measures a company’s operating profitability thereby also measuring the effectiveness of management. This ratio allows one to compare similar companies within the same sector because it excludes non-operating effects that are unique to every company.

Copper, nickel and zinc were over half of earnings in 2014 with copper being the largest contributor of the three. The cash cost or cost of production for copper, coal and zinc is targeted to be below $1.40/lb, $40/ton and $0.45/lb  respectively for 2016 while nickel is targeted to be below $3/lb. These costs are well below current spot prices for these commodities. Copper would have to be at $1.50/lb for Glencore to be worthless.

Glencore would generate free cash flow at current spot and is capable, even at today’s lower commodity prices, of making EBITDA of between $7 billion to $7,5 billion over a full year.

Note that Glencore is more sensitive to movements in commodity prices than BHP, RIO Tinto and Anglo. A 10% move in a commodity has a 20% impact on Glencore’s EBITDA, up or down. Versus 15% for BHP or Anglo and 10% for Rio. The effect on earnings is highlighted. A 10% move in a commodity has a 20% impact on EBITDA but an 80% impact on bottom line earnings in a static modeling scenario assuming that it prevails for a full year. For BHP or Anglo the effect is less – about 35% - whereas for RIO Tinto it is 20%.   

The recent placing (a mechanism used by companies to raise capital by issuing shares) raised £1,6 billion or $2,5 billion at 125 pence. 1,3 million shares is 10% of the share capital. Management took proportionate allocation to the extent of 22%.

This will help reduce interest charges and is part of a goal to get net debt to $27 billion.   

With net interest at around $1,4 billion in 2015 then EBITDA interest cover is 5x – which is quite comfortable if we assume bottom of the cycle commodity pricing. The interest cover ratio measures how many times over a company could pay its current interest payment with its available earnings.

Trading is a sizable part of the business and the most stable income stream relative to mining, which is very sensitive to movements in commodity prices.

Capex (Capital expenditure) is being cut, reducing cash flow pressure. Capex is targeted at $5 billion in 2016.   

As the group has no debt covenants there is no breach level where a covenant is triggered. Covenants are put in place by lenders (i.e. banks) to protect themselves from borrowers defaulting on their obligations due to financial actions/decisions that have a negative impact on the business. This is often represented in terms of financial ratios which must be maintained for the business, for example the maximum debt-to-asset ratio. Once the covenant is broken the lender will typically have the right to call back the obligation from the company. There is little evidence of elevated counterparty risk having emerged. Moreover, the banks have no naked exposure to Glencore because it covers its trades with very liquid and hedged trading inventory. Funding is marked to market with backing collateral in sync with the underlying commodity.

A bumping along the bottom scenario for ever and a day, with copper at $2,00/lb, suggests that at peer group multiples Glencore is worth an equity value of 70 pence on 14,586 billion shares in issue.

A low road scenario with copper averaging through the cycle at $2,50/lb indicates 180 pence per share.

A realistic fair value closer to 200 pence per share is defendable. Just as £3 per share was probably a bit too optimistic not too long ago so too is 70 pence or 90 pence doomsday. 

Glencore is a Buy below 100 pence on a very bearish lower longer commodity cycle scenario. Fair value of up to 200 pence per share is defendable on reasonable commodity price assumptions in relation to cash costs of production.