Glencore’s debt move a ‘doomsday’ precaution
Shareholders feel the pain as mining giant builds its bunker
AT the end of a two-week roadshow to meet with shareholders across Europe and the US, it was clear to Glencore CEO Ivan Glasenberg and his management team that some radical measures would be required to restore confidence in the embattled mining giant.
Shares in the company had nose-dived over the past month, down by as much as 40% to 122.75p each, as concerns grew that Glencore would be unable to manage its $29.5-billion (about R405-billion) debt pile should commodity prices continue to slide.
“We kept getting asked the same question by investors during the roadshow: ‘What happens if commodity prices drop further?’,” said Glasenberg.
“We don’t believe in this thesis, we believe it is a real doomsday scenario, but we wanted to bullet-proof the balance sheet.”
However, the radical decision to suspend its dividend for 2015, cut copper production in Africa, sell assets and raise capital in an effort to cut its net debt — excluding trading operations — by a third to around $20-billion is a dramatic turnaround by Glasenberg, who had previously said worries over Glencore’s balance sheet were overstated.
The commodities veteran has maintained that Glencore had plenty of financial levers at its disposal to bolster its balance sheet if required. It has now decided to pull them all at once — a bold bid to restore confidence in a company whose shares stood at 530p in 2011.
In committing to slash its debt to around $20-billion by next year, Glencore claims it will have built a “fortress-like” balance sheet.
Glasenberg and the rest of Glencore’s senior management, including chief financial officer Steven Kalmin, have put their own money on the table by investing up to 22% of the $2.5billion equity fundraising.
However, among the doubters questioning the company’s previous strategy of weathering the storm in commodities without taking the knife to dividends, or turning to the market for additional cash, were the ratings agencies.
Standard & Poor’s had placed Glencore on negative outlook primarily because of its bleak view on where commodity prices may be heading.
S&P spared Glencore’s all-important debt rating from a downgrade — a move that would have sent the FTSE 100 company’s financing costs rocketing. Nonetheless, the message for Glasenberg and Kalmin was clear, even if they deny that the decision to cut the company’s borrowing levels was influenced by the ratings agency.
“Had this been on the table before the [S&P] announcement, they would not have put us on negative outlook,” said Kalmin.
“This really is to meet the doomsday, Armageddon scenario.”
Before commodities markets get to that point of implosion, more mining houses, especially in areas such as copper production, will be forced to shut down an increasing volume of production. This process would eventually restore some support to the market, Glasenberg said.
Shares in Glencore bounced in London after news of the debt-reduction plan, but analysts still expressed concerns that the company may be too highly leveraged even after it has raised the $10.2-billion it seeks. Bank of America Merrill Lynch upgraded the company to neutral but cautioned that it would remain highly geared at around three times earnings.
Weakness in copper prices has been another factor weighing on Glencore over the past year. The base metal was expected to be among the commodities that would come through the current downturn with its demand intact, but the weakness in China’s economy has shattered this perception.
Glasenberg has often argued that mining companies must do more to manage prices by cutting back on overproduction, which some argue has been a major cause of the downturn.
By cutting 400 000 tons of copper production over the next 18 months, he hopes to restore some parity to prices, which have fallen 50% over the past four years.
“These cuts in Africa are not just about supply discipline. We’re keeping the copper in the ground for better days,” he said.
By suspending its dividend, Glencore has taken the risk of alienating investors who have traditionally viewed mining companies as safe bets. Maintaining progressive dividends had previously been thought to be sacrosanct, with the big mining companies choosing to tighten up their balance sheets by cutting capital and operating expenditure.
Although Glencore’s management say they will restore the dividend, trading conditions permitting, it is likely that other companies in the sector with similar debt profiles will now review whether they can afford to persist with rewarding shareholders at the same level they did during the commodities super-cycle.
Glencore may have been wise to be first out of the traps in reducing its debt profile. But only time will tell whether the market will reward it. — © The
In committing to slash its debt Glencore claims it will build a ’fortress-like’ balance sheet