2023-10-31 09:34:42 ET
Summary
- Glencore is in the top five producers of the following metals: nickel, zinc, copper, aiming to expand its metallurgical coal business through the acquisition of Teck Resources' coal assets.
- The company's 1H2023 and 3Q23 results showed declining revenues due to lower commodity prices and declining output, but Glencore expects better performance in the second half of the year.
- Glencore dividend yield is the best among its peers. To obtain a yield of 8.8%, we pay an EV/EBITDA of 3.8.
- Price action has yet to validate the timing. A confirmed breakout above 50WMA is an actionable signal. Till the price confirms the timing and Glencore and Teck reach an agreement, I prefer to stay on the fence.
Introduction
Mark Rich is a legend in the commodity business. He is the man behind Glencore (GLCNF), one of the most prominent commodity traders in the world. The company had extreme success and minted several billionaires. Among them is Ivan Glasenberg, who replaced Rich as CEO 12 years ago. In 2021, he retired and passed the helm to Gary Nagle.
Glencore is a true behemoth in commodity businesses. It is one of the largest companies involved in extracting, treating, shipping, and marketing coal, copper, zinc, and cobalt. Glencore is aiming to expand its metallurgical coal business. If the company plans to acquire Teck Resources’ ( TECK ) coal assets, its profitability will be boosted immensely.
The company has adequate finances and pays generous dividends. With growing commodity prices, the company profits will multiply, and shareholder returns will increase significantly. Among the shareholders apart from Glasenberg are Daniel Badanes and Aristotelis Mistakidis. Both made their fortunes as Glencore traders.
The company trades at record-low EV/Sales and EV/EBITDA multiples, as shown in the graph below.
Rising commodity prices will reprice Glencore shares significantly. In 2013, EV/EBITDA reached 25.3. The risk-reward ratio at the current prices is exceptional, given EV multiples.
Glencore at glance
Glencore operates globally. Its headquarters are in Baar, Switzerland. Marketing Activities and Industrial Activities make up its two main operating segments. The chart below from Market Screener gives a glimpse into Glencore's activities.
Asian and European customers generate 75% of total sales. The rest are divided between the Americas, Africa, and Oceania. The marketing segment still produces more than 80% of the company’s revenue. However, Glencore has expanded its industrial assets over the last decade. The company has been on a shopping spree, acquiring a mining business.
Glencore's marketing activities cover many commodities: iron ore, coal, crude oil, natural gas, nickel, zinc, copper, cobalt, lead, chrome ore, ferrochrome, vanadium, aluminum, and alumina. The company is focused on fossil fuels with an accent on coal mining. Glencore aims to become a global leader in the metallurgical coal industry. Xstrata's acquisition of Glencore was the first step in the coal mining business. The next decisive step is to take over the Teck coal assets.
Besides coal, the company is the fifth largest copper producer globally. Glencore is the leading cobalt miner , too. The company operates two of the largest copper/cobalt mines in Africa: Mutanda and Katanga in the Democratic Republic of Congo ((DRC)). Nickel is another primary source of revenue. Apart from cobalt and copper, the company is among the top five nickel and zinc miners in the world.
1H2023 results
The company's mining division realized declining revenues in 1H23 due to lower metal and coal prices. The company`s EBITDA dropped to $7.4 billion, down from $15.0 billion for the same period. The graph below from 1H23 presentation gives highlights of 1H23:
The metals and minerals segment had an EBITDA of $3.1 billion, down from $5.9 billion for 1H22. The copper revenues shrank by $1.2 billion, with the African copper market notably seeing a reduction from $987 million in EBITDA to $172 million.
According to the company, there is currently an oversupply of cobalt on the market as a result of both supply and demand dynamics. However, the long-term fundamentals for cobalt are favorable due to growing demand in electric vehicles (EV) and non-EV applications. Cobalt prices decreased by 59%, while the company's cobalt hydroxide revenues shrank more than 60%.
The graph below shows Glencore cash cost and margins per commodity.
Glencore`s energy division had suffered significant declines in revenue and EBITDA. The primary reason is the steep bear trend in coal prices. On the other hand, costs per ton are rising due to structural inflation impacting all operational expenses.
Glencore expects its metals business to perform better in the second half of the year than the first, with volume projections ranging from 50% to 55%. The demand for base metals (copper, zinc, nickel) largely depends on the global economy. The US and China reported a GDP growth rate of 4.9%. That figure is positive for the demand for industrial metals in 2H23.
The energy segment, I expect, will realize better figures 2H23 because of seasonality. Glencore major buyers are Asian and European companies where the winter season approaches. Thermal coal prices increased from $113/ton in July to $159/ton in September. Currently, the price is $135/ton.
3Q23 Results
Yesterday, Glencore published results from the last quarter. The table below from the last production report shows the Glencore production figure.
Glencore Q3 report
The figures are lower than 3Q22. However, as per Glencore`s CEO, Gary Nagle, they meet the company`s forecasts. Below is his quote from Glencore's performance.
he full year 2023 production guidance for copper, zinc, coal, and cobalt remains in line with previous guidance. However, nickel has been reduced to reflect, within the INO business, maintenance outages at the Sudbury smelter and a longer than expected recovery from the 2022 strike action, together with a lower full-year revision for Koniambo. Ferrochrome production has also been marked lower due to additional smelter off-line days on account of electricity pricing and load curtailments in South Africa, however, chrome ore mining production is expected to only be modestly below 2022 levels.
“In our Marketing segment, we continue to expect the full year 2023 Adjusted EBIT outcome above the top end of our $2.2-3.2 billion p.a. long-term guidance range, with a likely outcome within the previously communicated $3.5-4.0 billion range.”
Copper production decline is primarily due to lower output in the Antamina and Collahuasi mines, at 11% and 4%, respectively. On the other hand, DRC copper mines delivered adequate results, though insufficient to compensate for South American assets' lower output.
The coal division achieved better results at 2%. Glencore coal assets had mixed results. Much of the 3Q23 production growth came from the Cerrejon mine in Colombia and South African thermal coal mining. The company`s Australian assets achieved disappointing results, with a 16% decline in cocking coal production.
Silver and ferrochrome output dropped 19% and 21%, respectively; however, they represent a small fraction of the company’s revenue, below 5% combined. Ferrochrome production declined due to smelter offline days caused by power outages.
The nickel production suffered a decline of 16%. It is attributed to the strike in the Raglan mine. Glencore lowered its 2023 nickel production guidance by 9%. The primary reason is Sudbury smelter's off time for maintenance.
The table below shows production guidance by product.
Apart from the nickel, the other division is expected to achieve its targets.
Glencore and Teck
Glencore's next acquisition target is the Teck Resources coal business. Since the proposal in June, neither company has reached an agreement yet. The table below from the Glencore presentation compares Teck's and Glencore's proposals.
Looking at the table, the deal seems to be profitable for both sides. However, I disagree. It is a one-sided transaction that is more beneficial for Glencore than Tech shareholders. If the merger is successful, Glencore will cement itself as one of the major metallurgical coal producers.
Let's go into some details about the deal. Glencore plans to pay cash for Teck's metallurgical coal division Elk Valley Resources ((EVR)). This one is replacing Glencore's earlier proposal of a merger-demerger. EVR is being purchased to enable a value-adding split of the combined coal and steel business (CoalCo) for Glencore's shareholders. Glencore plans to split CoalCo after lowering its debt within the next 12 to 24 months. Glencore's net debt will fall from its current $10 billion to roughly $5 billion following the demerger.
Teck, like Glencore, has multiple mining operations for copper, zinc, and coal. The company is second to BMA globally in metallurgical coal production. Its mines are in safe jurisdictions such as Canada and Australia. The map below from the Teck merger presentation provides Teck and Glencore assets locations.
Tech proposed merger presentation
Glencore operations are scattered across the globe in higher-risk countries. Only 19% are in safe jurisdictions. Teck coal resource and reserve base is enough for at least 30 more years of operations. The graph below shows Teck steelmaking coal figures.
Teck proposed merger presentation
In the long term, acquiring the Teck metallurgical coal business is a smart move for Glencore. Nuclear energy will gradually push out coal-fired plants; however, in steel production, the coal is here to stay for longer. Various alternatives to coal-fired furnaces have been discussed, looking good at first glance. However, digging deeper reveals they cannot substitute coal-fired blast furnaces, at least for now. Simply put, the demand for metallurgical coal will stay and grow longer.
Company Financial
Glencore operations are CAPEX and OPEX intensive. I start with capital structure and liquidity to estimate a company's survivability. The graph below shows solvency and liquidity ratios.
Total liabilities to total assets are at 66%, an adequate figure for capital-intensive business at such a scale. Long-term debt to capital is at 28%. This means that for $1 of capital, the company borrows $0.28 in long-term financing. Interest rate coverage is robust, too. Even subtracting companies, CAPEX Glencore has funds to cover interest expenses for eight years.
The chart below compares Glencore`s balance sheet to those of other major miners.
Glencore is more indebted than its peers. Its Total debt-to-equity ratio is 71%, while the second BHP ( BHP ) is 49%. Long-term debt to total capital is not excessively high despite being the highest in the group.
As discussed above, the company`s margins had declined in 1H23 compared to 1H22. However, Glencore has been profitable for the last three years.
Another way to measure capital allocation efficiency is to compare CAPEX as a percentage of revenue and FCF yield.
Glencore excels here with a 10.49% FCF yield and CAPEX/Revenue at 1.91%. Simply put, the company has excess funds to invest in business expansion.
Measuring return on capital to assess enterprise efficiency is not enough. Using ROIC in isolation gauges a company`s profitability; however, by adding the total debt/total capital ratio, we can estimate how efficiently the company allocates its capital.
Glencore is not the most efficient major miner. BHP, for example, realized 19.32% ROIC at Total Debt/Total Capital at 22.8%.
Valuation
To estimate Glencore`s value, I compare the company`s EV/EBIDTA, EV/Sales, and PE multiples within three sets of data:
- Glencore's ten years average
- Global materials
- Global broad market
Glencore is relatively cheap, looking at the data sets. EV/EBITDA multiple resides in the lowest 11 th percentile, while EV/Sales in the 28th percentile of Glencore has a year history. The situation analyzing Glencore vs Global Materials is similar.
Another way to assess what I pay and get is to compare EV/EBITDA vs dividend yields for similar-sized companies (Market cap above $30 billion).
Glencore dividend yield ((TTM)) is the best among its peers, while EV/EBITDA is the lowest percentile. To obtain a yield of 8.8%, we pay an EV/EBITDA of 3.8. It sounds like an excellent deal, adding that the company`s EV/EBITDA has reached a long-term bottom.
Price Action
The company's qualities and discounted price are mandatory but insufficient arguments to enter the market. The missing ingredient is the timing.
I use the SQN indicator developed by Van Tharp. It indicates four market regimes: bull volatile (blue), bull quiet (green), neutral (yellow), bear subtle red), and bear volatile (dark red). Currently, the price is in a bull-quite regime. Last week, the candle closed just below 50 weeks moving average ((WMA)). The WMA coincides with the horizontal resistance level. If the price closes above WMA and the resistance, it will give the signal. Till then, I prefer to wait patiently.
Risks
Glencore is one of the major mining companies globally. The primary risks are operational due to the company`s operations being scattered across high-risk countries. Another complication is Glencore`s multiple mining activities: copper, zinc, nickel, thermal and metallurgical coal. I expect the company`s management to handle those complexities well.
The recession risk is always on the table. A shrinking economy will hit hard base metals and metallurgical coal. So, Glencore profitability will significantly decline. The last US GDP report is encouraging, though it does not mean recession risk is off.
Failure to acquire Teck`s metallurgical coal business will disappoint Glencore shareholders, including myself. However, I am not surprised by the Teck shareholder's resistance to the deal. It is not as bad as they claim, but it is not as rewarding as Glencore promises.
Investors takeaway
Glencore is a major commodity trader and producer. It already holds leading positions in cobalt, copper, zinc, and nickel mining. If the company acquires Teck coal assets, it will become a significant metallurgical coal miner. Glencore has an adequate balance sheet compared to its peers. The company is profitable using FCF yield, though it is not the best capital allocator among its peers.
I use EV/Sales, EV/EBITDA, and PE to estimate a company's relative value. Glencore is cheap compared to its ten-year history and its global peers. Glencore dividend yield is the best among its peers, while EV/EBITDA is the lowest percentile. To obtain a yield of 8.8%, we pay an EV/EBITDA of 3.8. It sounds like an excellent deal, adding that the company`s EV/EBITDA has reached a long-term bottom.
Price action has yet to validate the timing. A confirmed breakout above 50WMA is an actionable signal. I am looking forward to completing the Teck coal assets acquisition. Till the price confirms the timing and Glencore and Teck reach an agreement, I prefer to stay on the fence. The verdict is a hold rating.
For further details see:
Glencore: On The Sidelines Despite Attractive Dividend Yield