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The investment case is clouded by several major issues
Thursday 25 Feb 2021 Author: Yoosof Farah

Mining company Glencore (GLEN) has long been a source of intrigue for investors but we feel prospective investors should hold off on buying the shares until it resolves a number of issues.

On the face it, the investment case looks clear – Glencore has been described as the world’s largest middleman for the raw materials that fuel, feed and underpin civilisation.

THE COMMODITIES MIDDLEMAN

It’s the biggest commodities trader in the world, putting it in a great position whenever there’s a boom time in commodities, some predicting a super cycle for this decade.

It is also one of the largest mining companies globally in its own right, digging metals out of the ground like cobalt, copper and nickel – attractive commodities which are all set to see structurally higher demand and significant price growth as the world moves to renewable energy and electric vehicles.

Combine that with its huge cash generation, stable balance sheet and more than palatable valuations of 1.4 times price-to-book or 11 times forward price-to-earnings according to Stockopedia, apart from the general ups and downs of the commodities markets it could be hard to see where the downside is with Glencore.

But this is a company that, despite its presence in the FTSE 100 is embedded in secrecy.

Based in the sleepy town of Baar in Switzerland, this lack of transparency has drawn ire from many investors down the years.

CHEQUERED RECENT HISTORY

It has faced repeated criticism for some of the deals it has done, particularly     in some of the poorest and most corrupt countries in the world, and is under investigation by various regulators, with each probe weighing further on its share price.

In 2018 the US Department of Justice (DoJ) launched an investigation into Glencore, examining possible violations of the Foreign Corrupt Practices Act in its operations in Nigeria, Venezuela and the Democratic Republic of Congo (DRC).

Liberum analyst Ben Davis told the Financial Times at the time that investors weren’t just concerned about the fact it could face a substantial fine as a result of the investigation, but that ‘everyone is worried about what else they have got in the closet’.

Following on from the US DoJ investigation, the US Commodity Futures Trading Commission initiated a probe in April 2019 looking at whether Glencore had fallen foul of certain provisions of the Commodity Exchange Act and engaged in ‘corrupt practices in connection with commodities’. The UK Serious Fraud Office then opened its own investigation in December 2019 over suspicions of bribery.

More recently, in June 2020 the Swiss Attorney General launched a criminal investigation into the firm (its fourth regulatory probe in less than two years) regarding a ‘failure to have the organizational measures in place, to prevent alleged corruption in the Democratic Republic of Congo (DRC).

An award-winning investigative feature by Bloomberg in November 2018 detailed alleged corrupt practices as Glencore looked to gain access to huge cobalt deposits in the DRC.

HOW IT MAKES MONEY

Glencore makes it money in two main ways – mining, which it calls ‘industrial activities’, and trading, known as ‘marketing’. Founded in 1974 by commodities traders Marc Rich and Pincus Green, its name is an abbreviation of ‘Global Energy Commodity Resources’.

Before becoming a big diversified miner, it was focused on trading commodities and this accounts for around 28% of its earnings, with mining activities accounting for 67% and the rest coming from what Glencore calls ‘corporate and other activities’, relating to earnings from holdings in other companies like the privately-owned Viterra, a Canadian grain-handling business formerly known as Glencore Agriculture.

The company has been led since 2002 by charismatic chief executive Ivan Glasenberg, a no-nonsense 64-year-old South African who’s the son of Lithuanian immigrants and back in the day was a champion speed walker.

He is set to retire in June 2021 but to understand  Glencore today you need to understand Glasenberg, one of the mining industry’s most prominent figures.

Glasenberg joined the firm’s coal division as a trader in 1984 and worked his way up through the ranks before landing the top job having been part of a group of executives who bought out founder Rich’s controlling stake in the firm.

Described in press reports as ‘hard’, ‘relentless’ and ‘blunt’, Glasenberg is said to be more focused on physical materials, the mines and where the materials end up as opposed to the abstract numbers involved in the trading of commodities.

Glencore says the majority of its earnings comes from the ‘metals and minerals that enable the transition to a low-carbon economy’, pointing out it is one of the largest global producers of copper, nickel, zinc, vanadium and cobalt and says it will ‘continue to prioritise investment into these commodities.’

ELECTRIC VEHICLE FOCUS

Glasenberg has been obsessed for a number of years with metals key to the electric vehicle revolution, and proudly told investors at an annual meeting months before its first regulatory investigation that the firm is ‘best-placed of all the large-cap companies to take advantage of this electric vehicle phenomenon’.

This explains why Glencore has pushed heavily into cobalt for example, which currently only makes a small contribution to earnings but could increase significantly as it continues to ramp-up its Katanga mine. In past AGMs Glasenberg has reminded shareholders of predictions that global cobalt production would need to treble by 2030 to keep up with demand.

Its main commodities at the moment are copper, zinc, nickel and coal. Copper makes the biggest contribution to the group’s earnings, and this year Glencore is forecasting EBITDA (earnings before interest, tax, depreciation and amortisation) from copper of $6.7 billion, out of a total implied group EBITDA of $16 billion, according to guidance in its 2020 results presentation.

The company’s significant interest in copper dates back to around 2006 as Glasenberg spearheaded a push to mine the commodity having reportedly been convinced that China’s appetite for it was ‘insatiable’, with the economic bellwether metal used in everything from household appliances to the electrification of infrastructure.

Zinc is expected to be the next biggest contributor to Glencore’s earnings at $2.8 billion, followed by coal at $2.5 billion and then nickel at $1 billion.

A DIRTY LEGACY IN COAL

Glencore is still a big producer of thermal coal, the ‘dirty’ kind used as a source of energy, unlike metallurgical coal which is mainly used a key ingredient for steelmaking.

Rivals Anglo American (AAL), BHP (BHP) and Rio Tinto (RIO) have all either sold out of thermal coal entirely, or have committed to selling off all their assets producing the commodity.

Glencore hasn’t gone that far, perhaps understandably given its contribution to the group’s earnings, but has said it will show ‘responsible stewardship’ of its ‘declining’ coal business ‘over time as the industry decarbonises’.

Glencore announced its preliminary results for 2020 on 16 February, the last under Glasenberg. The miner ticked most of the boxes set by analysts.

It missed revenue expectations with a 34% drop to $142.3 billion, compared to the $157.1 billion analysts had anticipated, but on the plus side it reinstated its dividend with a payout of $0.12 per share, equivalent to a roughly 3% yield, and raised the prospect of further increases in returns to shareholders if commodity prices stay strong.

That came as adjusted EBITDA, a measure tracked by analysts, hit $11.6 billion, unchanged from 2019 but a full $1 billion more than market forecasts.

Glencore’s net debt was also in focus and this has been cut by $3.9 billion in the second half of 2020 to $15.8 billion in total, within its target range of $10 billion to $16 billion and paving the way for the dividend to be reinstated.

Having reported free cash flow of $7.2 billion following bumper commodity prices, it hopes to now have a ‘fast-track pathway’ for getting net debt down towards the lower end of its range.

CLIMATE STRATEGY

In addition, the company also unveiled a ‘sector-leading’ climate strategy, targeting a 40% reduction in total CO2 emissions by 2035 and a 2050 net zero ambition for Scope 1,2 and 3 emissions, and it says it will put the plan to a shareholder vote at its AGM.

This has been welcomed by investors, in particular Royal London Asset Management, whose senior responsible investment analyst Carlota Garcia-Manas thinks it ‘constitutes another big step’ in Glencore’s ‘transformation’ and ‘climate evolution’, adding that Glencore is ‘one of a few companies leading the way’ on climate issues.

The uptick in commodities prices culminating with its annual results has given Glencore’s share price a shot in the arm, soaring around 90% since the start of November, but its shares are still trading a lot lower than the 380p mark they were at before the latest round of investigations started, indicating that professional investors are still cautious on what the future holds for the company.


SHARES SAYS:  It may be tempting to buy the shares now given they still look relatively cheap when you consider the company’s exposure to commodities underpinned by structural growth drivers. However, we think it is prudent to wait until the clouds cast by the various probes facing the business are over and there’s evidence Glencore is getting its act together on governance and its social impact.

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