The prospect of enduring supply imbalances across commodity markets makes diversified diggers Rio Tinto (LSE: RIO) and Glencore (LSE: GLEN) a risk too far, in my opinion.
As part of its plan to slash its debt mountain, Glencore has taken steps during the past year to cut output across its copper, zinc, lead, coal and oil operations. The Zurich-based firm saw its own copper production slip 4% during January-March as a result, to 335,000 tonnes, while zinc and coal output fell by double-digit percentages.
Although critical in helping to reduce costs, a lack of cutbacks from the rest of the industry is making folly of Glencore’s actions.
Instead, a stream of project expansion schemes — from Rio Tinto’s Oyu Tolgoi copper asset to Vedanta Resources’ huge Gamsberg zinc project — threaten to keep markets swamped with unwanted material for some time to come.
And when you throw in the issue of China’s cooling economy, it comes as little surprise that metals prices continue to struggle. Bellwether copper continues to toil below the $5,000-per-tonne marker in a worrying sign for all commodity markets. Should Chinese exports extend the 4.1% slip reported back in May, then the clouds hovering over the raw materials sector are likely to darken even further.
Sales struggles
Oil prices have held up considerably better in recent months, the Brent benchmark continuing to trade around $50 per barrel thanks to supply problems in Canada and Nigeria.
This will provide some respite to Centrica (LSE: CNA), whose upstream operations have been hammered by plummeting oil prices. The company’s Centrica Energy arm saw adjusted operating profits slump by almost two-thirds last year.
But any additional upside for crude values could be hampered by a fresh uptick in the US rig count, not to mention a steady rise in production from OPEC and Russian wells. Concerns are already doing the rounds that speculative buying has left oil prices looking precariously-overbought.
And of course Centrica still has to form a coherent strategy to defend its British Gas customer base against the progress of cheaper, independent suppliers.
Way, way too expensive!
And at current share prices, I believe that all three FTSE 100 (INDEXFTSE: UKX) firms are far too dear given their enduring revenues troubles.
Rio Tinto and Centrica deal on prospective price-to-earnings (P/E) ratios of 17.4 times and 13.6 times, respectively, sailing above the benchmark of 10 times indicative of stocks with gigantic risk profiles.
And despite the success of Glencore’s restructuring plan in slashing debt, the company certainly doesn’t merit a forward P/E rating of 44.7 times.
I believe these readings leave all three companies in danger of a significant retracement should industry news flow continue to disappoint. And in the cases of Rio Tinto and Centrica, a bigger-than-expected dividend cut in particular could send their stock values sinking.
