I would buy Glencore (GLEN.L) at these levels.
At 220p it has a market capitalisation of $35bn (USD/GBP 1.24).
Net Debt is $24bn, including financing for the Trading (Marketing) division it’s $32bn targeted.
That means an Enterprise Value (EV) of $52bn or $67bn respectively.
They made $4bn EBITDA in H1. If I use their full year 2016 output projections by product (Copper, Zinc, Nickel, Coal, i.e. excluding Lead, Ferrochromes, Oil and Ags (Agricultural products), apply spot prices and subtract their production costs (all of which they give in their presentations), they could make $7-8bn EBITDA in 2016 just from their Industrial division (mining). Add to that, say, twice their H1 profits in trading, so another $3bn, and that’s $10-11bn for the full year.
This means they are trading at 5-6x EBITDA, which is cheap, as mid-cycle multiples are more like 8x.
Every additional 1x EBITDA means over 50p more on the share price (25%); they produce $4.5bn of Free Cash Flow per year, which if it went to shareholders (they say they’re looking to reinstate the dividend next year) would be 28p or 13%. That’s the ‘Cash Flow Yield’. Unlikely to pay the full amount to shareholders when they’re trying to raise their credit rating from BBB- to BBB, so debt holders will be paid down in part. They also seem to have regained access to the bond markets, having raised CHF225m at 2.25% earlier this year, and CDS levels have ‘normalised’ (that’s credit protection, another measure of riskiness of their debt, which spiked late in 2015 on fears that they are acutely over leveraged, something the company has been working hard to dispel).
A target multiple of 8x EBITDA (by fully regaining market confidence) on EBITDA of $10bn implies a share price of 300-350p depending on whether one uses Net Debt or Net Funding, i.e. a 35-55% upside.
Excluding the Trading division (Marketing as they call it, it’s effectively a hedge fund or ‘black box’ in that they take proprietary positions in simple and complex ways which they don’t disclose, yet consistently make around $2-3bn profit while requiring about $10bn of debt, which is collateralised by minerals or products of some sort and thus they believe it not to have to contribute to their net debt figure), about half of the profits come from Copper. Next is Zinc, with about a third, and then thermal coal, which is a tricky one, as they need prices over $39 per tonne. The market was in the doldrums for a while until this year when to even their surprise, levels reached over $60. At this rate, they could be making over $2.5bn EBITDA on coal alone, except they chose to hedge it, or lock in lower prices earlier this year when coal prices where rising, and so lost $400m in the first half on this ‘hedge’, which still doesn’t tell us where they’ve capped their upside and how long for, but if it’s $50 per tonne, their profit is $1.4bn, and at $45 it’s only $750m.
How their Agricultural Division (Ags) is contributing is now less clear given that they’ve sold off various stakes in it, and so it contributes in a partially consolidated way i.e. we don’t understand quite what’s going on but they got some cash for it that’s reduced their debt and it seems wheat prices are low anyway this year so not worth expounding this subject. The positive is that the stakeholders here are financially strong and this implies further support for the parent, indirectly.
Copper prices have recovered to around $4,700 per tonne, and it was said earlier in the year that they’d have to come down to around $4,000 to force enough suppliers to close mines and deal with the overcapacity, however China (who uses over half of worldwide output) seems to be propping up its construction industry thus supporting demand while supply has reduced overall (even Glencore has 5-10% less output). So this does remain a bit of a China bet.
Overall, it’s a cheap stock with a deleveraging story buoyed by positive commodity price tailwind and the prospect of a dividend.
Update post US election: The stock is up along with Copper prices which briefly reached $6,000 per tonne as the Trump economic plan comprises creating jobs through massive infrastructure spending.