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Should I Invest In Glencore Xstrata Plc?

To me, capital growth and dividend income are equally important. Together, they provide the total return from any share investment and, as you might expect, my aim is to invest in companies that can beat the total return delivered by the wider market.

To put that aim into perspective, the FTSE 100 has provided investors with a total return of around 3% per annum since January 2008.

Quality and value

If my investments are to outperform, I need to back companies that score well on several quality indicators and buy at prices that offer decent value.

So this series aims to identify appealing FTSE 100 investment opportunities and today I’m looking at Glencore Xstrata (LSE: GLEN), the diversified commodity company.

With the shares at 338p, Glencore Xtrata’s market cap. is £44,903 million.

This table summarises the firm’s recent financial record:

Year to December 2011 2012
Revenue ($m) 186,152 214,436
Net cash from operations ($m) (343) 4,381
Adjusted earnings per share (cents) 72 44
Dividend per share (cents) 15 15.75

Glencore merged itself with Xstrata in May 2013 and one standout observation is that net debt has roughly doubled under the new arrangement compared to that stated in Glencore’s balance sheet the previous year. Debt is high at Glencore Xstrata, let’s be clear on that.

The enlarged group is well diversified in terms of the geographical spread of its operations and the resources it deals with. Investing in the firm will gain investors exposure to zinc, copper, lead, aluminium, ferro alloys, nickel, cobalt, iron ore, crude oil, coal and agricultural commodities (softs).

Right now, expectations are that earnings will advance by around 30% during 2014. Maybe, but as ever with commodity suppliers, the outcome is at the mercy of commodity prices, which can move to neutralise, or even reverse, the profit outcome. Either way, that improved profit forecast is already in the price in my view. I’m neutral with regard to total-return expectations, but I do see the debt here as a risk, which may come to the fore if commodity prices weaken.

 Glencore Xstrata’s total-return potential

Let’s examine five indicators to help judge the quality of the company’s total-return potential:

1. Dividend cover: adjusted earnings covered last year’s dividend around 2.8 times.   4/5

2. Borrowings: net debt is running at about 15 times expected operating profit. 0/5   

3. Growth: growing revenue and cash flow with falling earnings.   3/5

4. Price to earnings: a forward 14 looks towards improving profits.  3/5

5. Outlook: satisfactory recent trading and an optimistic outlook.  4/5

Overall, I score Glencore Xstrata 14 out of 25, which inclines me to be neutral on the firm’s potential to out-pace the wider market’s total return.

Foolish summary

Right now, dividend cover from earnings looks good, and there’s a, roughly, 3% forward yield on offer. The borrowings are high and both cash flow and earnings look volatile. However, recent trading looks satisfactory and the directors are positive.

Rather than taking a bet on commodity price movements by investing in a cyclical company like Glencore Xstrata, I'm much more interested in the kind of potential growth that one of the Fool's top investment writers has uncovered. He has put his money where his mouth is by investing in a firm that he believes is the "Motley Fool's Top Growth Share ".

The report makes a convincing case for investment, explaining how the firm has re-envisioned itself to drive growth in new areas that it has identified as being attractive in today's economic landscape. The report is free to download and outlines the 'buy' case for this changing company with a strong pedigree. I think you'll find it's worth your while researching this opportunity and recommend getting your copy by clicking here.

> Kevin does not own shares in Glencore Xstrata.