Published in The Australian 3 October 2015
Global share markets have had a tumultuous quarter. Miners have been hit hard facing lower growth scenarios for longer periods and greatly reduced commodity prices. Some analysts are now questioning valuations and ultimate survival if commodity prices stay low, and Glencore is one of the companies under the spot light
Glencore is the world’s largest commodity trader and has significant world-wide assets with several major assets in Australia. Domestically it is the nation’s largest coal producer through its Australian subsidiary Glencore Xstrata.
The company disappointed the market in August when it missed earnings estimates, reporting a half year net loss of US$817 million. Early September, in an effort to counter negativity, they announced plans to reduce the US$29.6 billion net debt by a third. But, the market has savaged the company and the US shares trading at US$8.35 as at 30 June 2015 are now 70 per cent lower at US$2.42. Market capitalisation has plunged from a peak of US$85 billion to less than US$20 billion, well below the company’s debt.
The bonds have held up much better, although declined significantly in the last week. A five year US dollar bond issued in April was trading at US$98.41 as at 30 June, is now trading at US$78.75 (a 20 per cent decline) with an implied yield to maturity of 8.63 per cent per annum.
Source: Bloomberg, FIIG Securities
Data accurate as at 30 September 2015.
Analysing what happens when the outlook for companies deteriorates can be insightful when considering future investment opportunities.
Glencore operates in a cyclical commodity business, where investors can expect fluctuations in the value of their investments. Like with any company, the bonds will be less volatile than the shares in the same company as they are a legal obligation where interest and the initial loan amount must be paid. So bondholders will be protected at the expense of shareholders, as companies have no legal obligation in relation to shares to pay any dividends or return capital.
The company has tried to placate the market and instil confidence in investors by announcing a plan to reduce debt by a third to around US$20 billion by 2016. The measures include:
- Raising US$2.5 billion in equity.
- Suspending dividend payments.
- Reducing working capital.
- Selling assets - it is rumoured that Glencore ‘jewels in the crown’ Latin American copper mines Antamina and Collahuasi both estimated to be worth US$4 billion each may be considered.
- Cutting industrial capital expenditure.
- Reducing long term loans.
The focus for Glencore management at this point is ensuring it survives. Practically all of the measures above are supportive of the bonds and to the detriment of the shares. While management will be concerned at the significant fall in the share price, it will not see the company fail.
What becomes paramount as events unfold is Glencore’s debt maturity profile. When does the next large bond mature and how does Glencore fund the repayment? Just one missed payment date on its bonds is an event of default and the bond holders can put Glencore into a wind-up.
Next year Glencore has US$14bn of debt coming due with a massive US$8.45bn unsecured revolving credit facility due at the end of May being a key point of interest.
Should the worst scenario play out, most likely shareholders will be wiped out completely. Bond holders will likely recoup some of their investment, the average for an investment grade bond is around 40 per cent and this is ultimately the difference in risk between shares and bonds.
Please note that pricing is accurate as at 30 September 2015 and subject to change.