The company is reducing costs and buying back shares; they have maintained the interim dividend and are looking for a better second half. The shares strike me as being dramatically oversold and a screaming buy even if the share price chart looks weak. I think we have heard a bell ring.
We have now had the first half year interim results from Glencore (GLEN), a stock I have been thinking about as a potential buy since late last month when I noted that the share price had fallen 44% over the preceding year and 14% more than Rio Tinto (RIO), my favourite stock in the sector because of its productive efficiency and excellent cash flow. After the interim results for the six months to 30th June 2015, the share price is now down 54% over a year. The share price took a bit of a pasting on the results. So is it still a share for buying?
What is Glencore?
There are a number of things to be taken into account when profiling Glencore as an equity investment. First, mining material prices and mining companies, as investments, have proved significantly volatile over the long term, because of their big fixed operating costs and the related volatility of metal prices. The same is true of oil; Glencore, seeks profits from both.
Second, on top of its operational gearing, it has a remarkably high level of debt gearing in its balance sheet. At the end of last year, long term debt was reported as being valued at nearly 84% of balance sheet equity. That is a worryingly high level of debt to have in a balance sheet. It massively devours profits when the demand and value of metals and oil go down strongly, as they did last year. The latest interims give us our first glimpse of the impact of that gearing on profits.
Third, Glencore is notably different from other mining shares because it has a separate big metals and oil trading business. It is perceived to be more of a trading house than a traditional mining production company. It does a lot of buying and selling; and because that involves hedging its own house positions, making it in the minds of many a bit of an investment bank “casino” business. That is important not only in terms of profitability, but more so in terms of management psychology. The company seems uneasy with actually investing money in the big fixed costs of mining production, although it still does a lot of that. The company management present that as a bullish feature, saying that it can, through hedging and trading etc, actually make money out of a period of falling prices. So these particular results are a test of that theory, particularly in terms of whether the company made as much money out of trading, as it said it would. The share price (last seen) was 10% down on the week. To judge by that share price reaction to the figures, that claim seems questionable.
The interim results
These were the company’s adjusted version and not, so far as I can see, the unadjusted statutory results. There is a primary emphasis on EBITDA and EBIT, which are basically trading profits before interest, depreciation and amortization. Adjusted EBITA was reportedly down 29% year on year to $4,611 million, establishing a fact and one observation; the fact that Glencore equity is selling on 7.5 times the half year’s adjusted EBITDA and the observation that a reported annual decline of 29% does not seem too bad in the context of the fall in the price of metal and oil prices. The results reveal that the depreciation charge was $5.2 billion. That is a lot of cash flowing into the business; the shares are valued at 6.6 times that depreciation charge. Those facts should be factored into the reported net loss figure of $676 million in contrast to a corresponding net profit of $2,308 million in the same quarter the year before.
A bullish point was the news that capital spending (Capex) has dropped a massive 62% from $8,566 million a year earlier to $3,188 million. So the company is doing much to cut costs out of the business and to boost cash flow. In that connection, note that the interim dividend was maintained; moreover, that it also managed to reward equity holders with a $240 million share ‘buy back’ to the enhancement of earnings per share.
Total company assets, after value write downs, totalled $148 billion, which was 2.6% down on their previous valuation. Unhelpfully, the assets attributable to ordinary shareholders figure (known also as net assets) is not shown in the summary. One supposes that in statutory terms, the net assets figure took a significant knock from current losses and write downs. The fact that there seems to be no formal balance sheet presented along with these results, diminishes full equity valuation visibility and is to be lamented. However, searching through the full documentation on another site reveals accounts showing net assets of $48.3 billion down from a corresponding $51.5 billion. It also shows end cash of $3 billion.
Exceptional factors helping these results
Although demand and prices fell markedly, this was not the whole story. Glencore is not static but dynamic in its operations. It actually had more production to sell in certain areas during the first six months of this year, even if it was at much lower prices. Although copper production was down 7%, other areas of production actually rose significantly, including lead, gold, zinc, ferrochrome and oil where production was reported up 68%.
Conclusion
The share price is shown as being back to where it was five years ago. If you had invested in the company five years ago, you would, it seems, have made absolutely nothing. But this is still a company with vast assets, sales and cash flow. That suggests the company’s shares are oversold on fundamental grounds.
Against a market capitalisation of $34.5 billion, the latest balance sheet showing equity assets at a reported $48.5 billion, indicates that an investor now pays nothing for earnings. Put another way, on the basis of that arithmetic, an investor is paying 160p (last seen) for assets worth somewhere in the region of 225p. That is a remarkable outcome given the dramatic fall in ‘hard’ commodity prices we have seen; particularly in copper and crude oil. As stated above, the shares also sell on a particularly low valuation of operating cash and accounting period end cash of a reported $3 billion.
Technically, the annual share price momentum still seems to be downwards. But a five year share price chart offers the possibility of long term support at these levels.
Moreover, the company has held the interim dividend and bought back shares – both encouraging signs. The market consensus estimates a 23% fall in earnings this year but a 50% increase next year, putting the shares on that basis on a forward estimated PER of 11 times for 2016, with a forecast estimated prospective dividend yield of 7%. Either the market is discounting a dividend cut or the company is showing signs of generating a lot of extra cash, though management initiatives, with which to pay it – and probably indicating that by maintaining the interim dividend and undertaking a share buy back programme.
Like everyone else, I cannot see the future. But I can search for exceptional fundamental share value and I think it is to be found here, if you care to look for it. It strikes me as well oversold and a ‘screaming’ buy. Anyone selling the shares at this level, would require a powerful bearish vision at this stage to rationally justify doing so. Have a good look at this one.