Saying that it has been a tough year for Glencore (LSE: GLEN) would be an understatement.
Year to date, Glencore’s shares have fallen 62%, and the £13bn FTSE 100 company now trades like a penny stock.
And unfortunately, it’s almost impossible to put a value on Glencore’s shares right now.
Even the City’s top analysts are finding it difficult to get to grips with the figures. The simple fact of the matter is, few understand what goes on at Glencore’s trading division.
It’s this division that’s responsible for Glencore’s troubles and uncertainty surrounding the business.
Trading black box
Glencore’s trading arm is a huge force in the commodity world. Ahead of its 2011 initial public offering, Glencore disclosed that it controlled 60% of the world’s zinc, 50% of copper and 45% of lead markets. Also, the group has the world’s largest oil tanker fleet under management.
But to operate effectively, Glencore’s trading arm borrows heavily to boost returns — similar to the way City traders use short-term financing to improve returns on the trading floor. Glencore has $18bn in short-term loans outstanding, which it is using to fund its trading operations.
According to Glencore’s management, these short-term loans shouldn’t be a problem for the company as they backed by raw materials that can be sold right away.
So, in theory, the short-term debt isn’t an issue for the company, but what is a problem is Glencore’s reputation. You see, Glencore’s traders have a reputation for being extremely aggressive and taking on plenty of risk to drive returns, a strategy that works well in a bull market, but not so well when commodity prices are falling.
As a result of Glencore’s aggressive nature, analysts are now asking if the company has taken on more risk than it should have done.
Moreover, there’s a feeling that the company could be hiding something from investors. Along with its reputation for aggressive trading, Glencore also has a reputation for being extremely secretive.
Binary bet
Glencore’s trading arm earned $1.1bn during the first-half of 2015, around 76% of the company’s total earnings. So, in many respects the group is highly reliant on the success or failure of the trading division.
However, due to the black box nature of Glencore’s trading arm, it’s impossible to accurately value the company.
For example, analysts at Morgan Stanley believe that Glencore’s shares could rally to 217p within six months if commodity prices improve. If not, Glencore’s shares could fall to 17p. Analysts at Investec note that if commodity prices remain at present levels for an extended period, Glencore’s shares could fall to zero over the long term. Although, once again this thesis is invalid if prices recover.
And lastly, Goldman Sachs believes that if commodity prices fall another 5% on average, Glencore could lose access to the short-term funding needed to sustain its trading operations. Again, this thesis is invalid if prices recover.
