Where Next For Glencore Shares?

24th Aug '22 by Roland Head

3 comments 2346 reads

FTSE 100 commodity giant Glencore (LON:GLEN) has been one of the biggest beneficiaries of the war in Ukraine. The Swiss-based group has opted to continue owning thermal coal mines (used to generate electricity), rather than selling them. This has enabled it to play a big role in filling the supply gaps created by the shortfall in Russian coal exports.

Coal generated half Glencore’s profits during the first half of this year – more than the entire group made during the same period in 2021.

Shareholders are set to benefit from this windfall. Dividends and buybacks are expected to total $8.5bn in 2022. That’s nearly 10% of the company’s market cap.

However, while Glencore shares have outperformed the FTSE 100 and coal-less rival Rio Tinto, the company’s share price action since the start of the conflict has looked fairly muted to me:

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Especially when we compare this to the threefold increase in Glencore’s profits over the last year:

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One possible explanation is that the smart money saw the energy supply crunch coming, even before the war brought the situation to a head. Glencore’s share price has risen by 190% over the last two years:

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Another explanation might be that this is just another cyclical peak, and that profits will soon slump. After all, Glencore shares are – remarkably – still no higher than when the company floated at the peak of the last big commodity bull market, in 2011:

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Glencore is positioning itself as an energy transition firm that’s running down its coal assets responsibly, while investing in energy transition commodities such as zinc, copper and cobalt. I think CEO Gary Nagle may be painting a somewhat rose-tinted view, but I can see this story.

To some extent, I also share Glencore’s view that responsible ownership may be a better alternative to divestment.

While mining profits will always be linked to commodity prices, Glencore’s trading division has historically been able to deliver reliable profits, even during mining downturns. Can the company avoid a slump and deliver sustainable growth?

I’ve been taking a fresh look at Glencore’s financial metrics to find out more.

Value: cyclical risk

A ValueRank of 76 suggests that Glencore shares could offer fairly good value. Some of…

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aflash

24th Aug '22

A year ago you could buy 65% cheaper and a month ago for 25% less.

There was that scare in 2015 when a broker analyst concluded from the accounts that debt was higher than assets and the company was worthless.

The price fell below a pound.

Ironically that was close to its value.

Even buying then was not a smooth ride upwards. You had to sell in 2016 when it was considered worth 6 pounds and the price was four.

The value is now considered close to seven pounds.

To make a profit, one has to buy when the news is bad.

Faith required in owner-management.

It is a remarkable collection of mines in remote places, way up in the Artic, in the depths of the Congo jungle and in South America. Apart from the headline holdings they took on all sorts of concessions that others failed to make work.

Article explains the mechanics well,

To go further, an opinion on the commodity cycle, emotional strength and quick reflexes needed .

flashing blade

thank you for the detailed and clear analysis . Always interested to see interesting articles such as this that are outside the scope of the SCVR because my interest is in the construction and management of a balanced portfolio.

Cuddlesticks

1st Sep '22

For long term value investors I think it's important to consider the business in two parts: the commodity assets and the marketing/trading division. The company estimates average annual profits of $2-$3bn EBIT for marketing/trading. During volatile markets the division tends to perform strongly generating $3.7bn EBIT in H1 this year alone.

I believe this is a core competence of GLEN that the market undervalues because it doesn't believe these profits are sustainable (in the same way it allocates a lower multiple to Goldman Sachs profits versus other large banks). But this part of the business produced impressive results before, during and after COVID so I believe it is sustainably profitable during weaker markets with potentially significant upside during volatile markets, especially when commodity prices are strong.

For me, I think about Glencore by conservatively valuing the marketing/trading at the £20bn and say the remaining market cap is what you pay for the remaining assets.

Importantly management uses profits from bumper years to reduce the share count and pay special dividends.

Outside these crazy energy price times, Glencore's biggest business is copper followed by zinc and nickel. I believe this gives credence to management's strategy focussing on green energy transition. In the short term this means 'green asset' profits will suffer due to falling demand from China as well as weak global growth.

That said, alongside coal prices, I think there is near time upside from the strong USD in terms of valuation when you convert USD profits to GBP and compare to market cap in GBP.

A key issue for Glencore has also been legacy investigations into bribes which it looks largely to have settled earlier this year with US and UK regulators. I think its fair to say that in the past Glencore operated as if these were cost of business payments. The newly in place leadership seems, in my view, keen to operate the business both transparently and with ethical standards you'd expect to see in a large cap miner. I think this significantly de-risks the group against unexpected large legal pay outs, better aligning it with other major miners.

On the other hand, management had responded to the market's historic concerns on high gearing by systematically focussing on reducing debt pre COVID. This also helped explain historic poor share price performance as management focussed on debt reduction which also tempered historic profits. In my view, this partially reflected a transition from a privately owned specialist trading house, happy to borrow to exploit short term market price dislocations, to a large listed mining and trading group where share price is rewarded by predictable, sustainable profits.

In terms of inventory financed debt, its important to note that much of this is short term 30-90 day debt and the banks/other funders will have included a buffer to protect their capital against commodity price falls. The above mentioned trading capability further reduces the risk of 'negative equity' as do the long term 'take or pay' contracts Glencore has in place with e.g. Tesla. In addition, Glencore generates huge cash flows from operation $18.3bn in H1 versus a circa £60bn market cap.

As mentioned below, the best time to buy is at the bottom of the commodity price cycle, so the multi bag opportunity may have gone for the time being. But I still see significant long term value.

Overall, I'm a holder of Glencore as I believe:

the market under estimates the value of its trading division;
it has a diversified, high quality portfolio of green energy assets across multiple jurisdictions;
its proven to be an effective asset operator;
its hugely cash generative;
it has a sensible gearing and capital structure;
there are shareholder friendly policies in place (the former management team that floated Glencore remain large shareholders);
the new management team has turned the page in terms of settling legacy legal issues and operating with the standards expected of a leading global miner.

Where next for Glencore shares?

Value: cyclical risk

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Roland Head

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