Quite simply, those who say that Glencore (LSE: GLEN) might go bust have very little understanding of the dynamics that characterise the debt markets. As far as I am concerned, the big question now is how long it will take for its 90p stock to hit a valuation of at least 200p.
Speculation
I have not been bullish on commodities for a very long time, but I did not expect a 70% drop in Glencore’s equity valuation in 2015. Its 52-week range is 66.6p-344.5p, and the low end of that range was reached on Monday when GLEN plunged 30% the back of comments from analysts at Investec, who argued that nearly all of its the equity value could evaporate — “debt becomes 100% of enterprise value and the company is solely working to repay debt obligations,” they added.
Facts
Since its five-year peak of 370 points in April 2011, the CRB Commodity Index has fallen 47%. Over the period, Glencore has lost almost 80% of value — but the performance of the two had been very similar between May 2011 and 27 April 2015 (CRB -35% vs GLEN -40%).
It doesn’t take a financial guru to understand that if spot metal prices remain around these levels or drop further, Glencore’s equity could be worth peanuts — but then, about the entire commodity sector would go bust, and the top miners will engineer a way to pursue consolidation.
BNP Paribas shares my view. Its analysts argued today that Glencore’s “current valuation is discounting $3,500/t copper vs spot at $5,000/t; at this price 79% of the industry would be in cash losses on a C1 cash cost and 82% of the industry would not be able to cover its maintenance capex. Unsustainable obviously.”
But why has Glencore diverged from the CRB Index since late April this year?
200p or 400p?
Leverage and market volatility — this is a dreadful combination for value.
What I have seen over the last two quarters is that risk-off trades have punished the shareholders of companies whose balance sheets are severely stretched — and Glencore, whose equity value is currently worth less than half the value of its net debt, is one of them. As I already argued, there are risks surrounding Glencore and its restructuring, but 76% of its equity value is represented by hard cash that can be drawn without notice.
While its price-to-book value signals stress, the value of its current assets (excluding cash and equivalents) is 220p a share if we value them at 100% of their book value; I am also happy to suggest that valuation for Glencore’s equity because the banks who are close to Glencore would have more to lose than Glencore itself if one of their core clients went under — two of the three banks that priced its IPO at 530p a share in 2011 also arranged its 125p-a-share cash call on 16 September.
Debt
In June, Glencore rolled over $15.3bn of bank debt that was priced “at $ LIBOR plus a margin ranging from 40 to 45 basis points per annum“. Glencore was already troubled, but paid a ridiculously low spread over Libor to refinance its debt obligations. That’s because the pricing of loans in the primary market reflects relationships and ancillary business potential more than the credit rating. Some 60 banks reportedly joined the syndicate, and the deal was oversubscribed.
So, regardless of short-term reaction this week — widening credit default swaps spreads and plummeting secondary debt prices — my focus remains on the left side of the balance sheet rather than on the liabilities, but then a price target of 400p a share would have to be based on certain assumptions for other less liquid assets, and it’s too early for that, based on its restructuring plan.
The speed at which Glencore will reach 200p a share, of course, depends a multitude of and factors, including volatility — well, I think the first-half of 2016 could be a particularly good one for us all.
