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In the coal bunker

7 September 2015 By John Foley

For such an aggressive trader, Glencore is taking a very pliant approach to leverage. Harried by shareholders, the Swiss group announced a $2.5 billion equity-raising on Sept. 7 as part of a $10.2 billion debt reduction plan. This will leave it with a far stronger balance sheet than it previously said it needed. The drastic move offers a grim view of commodity prices that undermines the investment case for the sector.

Two weeks ago Glencore boss Ivan Glasenberg said the company could still generate positive cashflows at current low commodity prices. Investors felt otherwise. By selling assets, lowering capital expenditure, pruning inventory and cancelling its dividend, Glencore should lower its net debt to $19 billion, or double consensus forecast EBITDA for 2015. That’s a level of indebtedness slightly below rival Anglo American – to whom investors are next likely to turn their attention – and somewhat more than Rio Tinto and BHP Billiton.

Yet what looks like conservatism can also be read as a sign of future distress. Glencore’s target is for net debt to be no more than three times EBITDA, which suggests that in its stress-tested scenario that cashflow-like figure could fall by a third. Based on the sensitivities Glencore disclosed in August, that might imply a further 30 percent fall in the prices of copper, zinc and coal. If that comes to pass, the whole mining sector will be in even deeper trouble.

Quibbles over Glencore’s balance sheet may persist. The $26 billion group says its marketing inventories are as good as cash, but not all analysts and investors think that would hold true in a crunch situation. Deduct those and net debt would be almost twice as high.

The bigger questions, though, are for the rest of the industry, which is still paying generous dividends on the assumption that commodity prices will recover. Glencore will trade on an implied multiple of around 10 times its free cashflow after the balance sheet adjustments. Though that’s attractive compared with the rest of the sector, long-term visibility for future earnings remains poor.

Glencore has done enough to give itself a relative boost over its peers, and squished the short-sellers who had borrowed around 3 percent of its shares. But in doing so it has reinforced the idea that the mining business is in for bigger and deeper cuts.


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