Financial Mail - Investors Monthly
Ivan Glasenberg's comeback plan
Glencore’s fairground ride of the past month has left investors dizzy. And while comforting noises from the US Federal Reserve have provided some reassurance, the jury is out on whether commodity prices are in sustained recovery mode. Stephen Gunnion take
You know investors are on edge when a single broker’s note can wipe more than R80bn off the value of a single company within a day.
But so it was, when Hunter Hillcoat and his colleagues, sell-side analysts at Investec in London, gained their 15 minutes of fame with their now famous report on Glencore, published in September.
The conclusions were pretty alarming, implying that Glencore, the dual-listed commodities trader that floated for £37bn in 2011 and then audaciously bought out Xstrata, could be worth nothing if the status quo doesn’t improve and commodity prices drop further.
It sparked pandemonium. Glencore’s shares lost close to a third of their value in intraday trade on September 28, before closing 26% lower in Johannesburg.
It was a severe blow to the South African founder, Ivan Glasenberg, who has not only seen the value of his 8,4% stake tumble below R3bn, but also had to go cap-in-hand to the market with a range of cost-cutting measures to appease anxious shareholders.
These included slashing dividends, raising US$2, 5bn in equity and committing to $2bn of asset sales — all to convince shareholders it has a cushion to meet future obligations.
It seems to have worked, because Glencore’s stock has regained some composure. But the outlook for it and other commodities companies remains anything but certain.
In that note, Investec says it is still pricing in subdued commodity markets for several years to come — despite a rebound in prices after Glencore said it would cut production of coal, copper and zinc, and the US monetary authorities showed a reluctance to hike rates.
Investec’s reasoning is that the “coincidence” of excess supply and a slowdown in demand, particularly from China, means it’ll take until 2018 for balance to return once high-cost production exits the market.
It must be said, however, that others are less gloomy.
Overall, 17 analysts rate Glencore as a “buy” both in London and on the JSE, while there are 11 holds in SA and only three “sell” recommendations.
As a whole, the analysts expect its share price to gain nearly 50% from its current lows of around R24,50 to reach nearly R37 within the space of a year.
Graeme Körner, director of the Körner Perspective, says there’s increasing optimism that commodity prices are forming a base, driven by the cuts in production across the board.
“It is frankly impossible to predict the near-term price movements for commodities, especially as some commodities, for example copper, appear in part at least to be serving as a proxy for China. We sense though that oil, as an example, is reflecting greater balance in supply and demand, and we see this happening in other commodities as well,” he says.
“We also think commodity shares have experienced a bit of a relief rally, in part because they were discounting a bleak medium term outlook a few weeks back.”
Glencore’s rebound has been as sharp as its fall. On September 28, it hit R15,41/share on the JSE, but has since gained nearly 60% to R24,60.
But this was only after Glasenberg reassured investors of the strength of its credit lines, revealing he has backing from more than 70 of its creditors.
Farai Mapfinya, head of equities at JM Busha Asset Managers, says these credit lines are critical for Glencore’s trading business. Without financing, in other words, there is no Glencore.
But it seems the recovery in Glencore’s stock reflects the comfort that investors felt with the speed at which Glasenberg identified assets to sell to help reduce Glencore’s debt — such as its agricultural business.
“One of the key concerns was the level of debt and they have comforted the market that they will be taking care of that debt,” Mapfinya says.
Körner, who admits to not following Glencore as closely as some other commodity
companies, is not convinced of Glencore’s investment case.
“A lot of people said the combination of a commodities trading business together with having their own mines was a really compelling argument. But as a colleague said the other day, they are now naturally long, always long [on] commodities,” says Körner. “Frankly, other than speculating that Glencore only listed in SA as a precursor to making a play for Anglo American, I have never understood why they came and listed here.”
But Investec’s report questions whether investors can still find value in mining companies — particularly those that are highly geared. Mining companies “gorged themselves on cheap debt in a race to grow production” as China stimulated its economy after the global financial crisis, Investec argues.
“In the current climate, debt is fast becoming the most important consideration for mining company management,” it says. “Never underestimate the ability of debt to undermine the value of equity. ” That neatly sums up the problem that equity holders face when highly leveraged companies see their much-diminished earnings absorbed by the obligations of debt holders.
Despite its emergency measures, Glencore’s total debt — including cash and the value of commodities it holds for trading purposes — is now more than
$50bn, a chunky figure in anyone’s book.
Investec says this leaves Glencore weaker than the likes of BHP Billiton and Rio Tinto when commodity prices are low and with lower-margin assets than some of its mining peers.
Investec expects Glencore’s debt as a proportion of its total value to fall from 81% this year to 20% by the end of the decade, which is still twice that of BHP and Rio.
Still, Glencore has been quick to institute some of the tough decisions it promised back in August as part of its plan to cut net debt by a third to around $20bn by 2016.
Glasenberg and his top brass participated in the rights issue to prevent their stakes being diluted further. They’ll be feeling mighty hard done by already.
At one stage, Glencore was dubbed the “millionaires factory” in honour of the fact that it minted so many new millionaires when it listed in 2011. In particular, Glasenberg and his four main partners became overnight billionaires when the company floated in 2011 — the largest IPO in the UK.
But these newly wealthy Glencore executives have seen the value of their investment plunge dramatically since the share price plunge.
To add power to commodity prices (and the share price), Glencore has taken supply out of the market and has mothballed two copper mines — in Zambia and the Democratic Republic of Congo — until prices recover.
It is also looking at selling copper mines in Chile and Australia, which analysts say could fetch between $600m and $1bn.
Though its decision to curtail zinc production amounted to just 4% of global supply, zinc rallied as much as 12% on the news and ended 6% higher on October 9. Analysts said it wasn’t so much the amount, but rather what the company was prepared to do to shore up prices.
Glencore says current prices don’t “correctly value the scarcity” of its zinc resources. Still, taking some out of production will preserve the value of reserves in the ground, it says.
It’s a bold tactic which may just work: analysts say it could lead to a deficit in the market, so what Glencore loses in volume, it may recover in price.
There’s a human cost to all this, though.
While Glencore’s actions may ultimately benefit investors (who have seen the value of their holdings in the company slump more than 50% this year), they have contributed to the loss of jobs on mines in countries including SA, Zambia, Peru and Australia. Thousands of jobs have been axed. But the impact of Glencore’s actions has been felt more widely too: Zambia’s kwacha, for example, has slumped as the company scaled back operations in that country.
And for Glasenberg’s management team, once hailed as visionary for combining mining assets with a trading business, buying mines at the top of the market and selling at the bottom seems less so.
❛❛ To add power to commodity prices, Glencore has mothballed two copper mines until prices recover