Value hunters in the commodity sector are incredibly bullish these days.
Not only have a few City traders I talked to downplayed the threat posed by a material slowdown in China, but many of them have argued that Glencore (LSE: GLEN) could be the bargain of a lifetime at its current valuation.
Frankly, I wouldn’t be prepared to invest in it, and it’s too early to snap up the shares of smaller players such as those of Lonmin (LSE: LMI) and KAZ Minerals (LSE: KAZ), too. Here’s why.
Glencore’s Results & Reaction
Interim figures, which were released today, were a touch light, to put it mildly.
The stock of the commodity trader opened in positive territory at around 180p, but it plunged soon after to 167.1p (-5.1%), setting a new all-time low after this week’s record trough of 168.8p.
Why is that?
Adjusted operating cash flow of $4.6bn is down 29% “compared to H1 2014 owing to substantially weaker commodity prices,” which was not unexpected, yet the speed at which its net leverage is rising is worrisome, and could jeopardise its dividend policy as well as its credit rating.
Core cash flow is plunging at a faster pace than net debt, so net leverage has risen to 2.7x in the first-half of 2015 from 2.4x in 2014. Glencore is doing all it can to preserve its investment grade rating, which is “a financial priority/target,” it said today. Net debt is expected to fall further by the end of this fiscal year, but it’s hard to predict accurately the impact of the current commodity meltdown on cash flows over the period.
And this is a big problem!
Chief executive Ivan Glasenberg said that “against a challenging backdrop for many of our commodities, we have taken a range of pre-emptive actions in respect of our balance sheet, operations and capital spending/recycling in order to preserve our current credit rating and sustain our track record on equity distributions“.
The group’s “principal objective” remains to grow free cash flow per share and return any excess capital in “the most sustainable and efficient manner“, Mr Glasenberg concluded.
Capex cuts are on the cards, so the dividend could be safe for a while, but there are obvious risks in this environment. One of its core investors, Harris Associates LP, recently increased its stake to 4.5% over the last month, betting on a rebound in Glencore’s stock price.
It looks messy, in my view, so I’m not sure I’d want to hold any GLEN exposure right now.
Lonmin Is Not Cheap Enough
It emerged yesterday that Glencore is set to close its Eland platinum mine in South Africa in the wake of falling commodity prices, which is very bad news for platinum producer Lonmin, whose $300m market cap is rapidly falling.
In fact, its stock was badly hit yesterday, losing 7.6% of value during the trading session. That is a drop that comes after a 74% decline in value since the turn of the year! It’s not going any better today, with the stock down more than 5%.
Its shares are cheap, based on most metrics, but they carry risk and I doubt they could reward you over the short term.
Lonmin is not expected to be in the black this year and its stock is unlikely to offer any meaningful yield for some time. Its price-to-book value signals distress, in my view, so I’d recommend to hold Lonmin shares only to opportunistic traders whose portfolios are properly diversified.
KAZ Minerals: A High-Risk Trade
KAZ Minerals signed a new $50m revolving credit facility with Caterpillar Financial Services, it emerged earlier this week.
That is small change for a company whose market cap is $1bn, but whose enterprise value, which includes net debt, is $3.6bn.
Unsurprisingly, the stock of this copper producer has fallen off a cliff in recent weeks as the price of copper hit a six-year low — KAZ’s stock price is now down 44% for the year, and is currently trading at its record low.
Is it an opportunity, then? Well, to me, its fundamentals and trading multiples don’t suggest so.
