Investors have turned their backs on Glencore (LSE: GLEN) this year as they’ve become increasingly concerned about the group’s mounting debt pile.
These concerns have driven Glencore’s shares to a new low almost every month, and they reached a new all-time low this week. Year-to-date, Glencore’s market value has been cut in half.
Debt reduction
At the beginning of September, Glencore’s management decided to try and reassure investors about the sustainability of its debt pile by announcing a $10bn debt reduction package.
The package has been designed to reduce Glencore’s debt to management’s targeted range of 3x earnings before interest, tax, amortization and depreciation.
As part of the company’s debt reduction package, Glencore raised $2.5bn through a share placing earlier this week, issuing 1.3bn shares at a price of 125p. Glencore’s management purchased around $400m worth of the shares in the placing.
In addition to the cash raised from the placing, Glencore is planning to save $2.4bn by suspending its dividend and $1.5bn by selling down existing inventory. A further $500m to $1bn will be saved via reduced capex, and the balance of the $10bn will be made up with asset sales.
But the question is, will this debt reduction package be enough?
Complex business
Glencore is an extremely complex business, even some of the City’s top analysts are unable to get to grips with the company’s trading division. That said, the company does reveal its quarterly trading inventory figures, which are readily marketable commodities — Glencore counts these as cash. At the last count, Glencore had $17.7bn in readily marketable inventories and net debt amounted to around $29bn. Excluding inventories, debt exceeded $45bn.
But as a miner and leveraged trading house, Glencore is more exposed than most of its peers to the commodity market.
For example, analysts at Macquarie believe that the price of the three key commodities Glencore producers (coal, copper and nickel) would only have to increase by a total of 8% to rebalance the company’s balance sheet. That said, if the price of these commodities fell 8%, Glencore could be forced into conducting anther share placing.
Still, as no one really understands how Glencore’s trading operations work, these are only ball-park figures.
Risks remain
Glencore’s trading operations require the company to borrow heavily. So, the company will always have a higher level of gearing than its comparable peers, most of which don’t have a trading division.
With this being the case, the company certainly isn’t suitable for all investors. A highly leveraged black-box commodities trading business with a coal and copper miner on the side is going to produce volatile returns.
So, if you’re not comfortable with volatile returns and a high level of risk, a more defensive play such Unilever might be a better pick. For example, over the past three years Unilever has outperformed Glencore by approximately 35% per annum including dividends.
