Glencore (LSE: GLEN) is showing the mining sector how to act at a critical juncture in this business cycle. Yet its restructuring plan, announced today, sends mixed signals to investors.
Debt Pile
The miner will issue up to $2.5bn of new equity capital to trim its debt pile. Additionally, it will implement other measures aimed at saving $7.7bn.
Trading was suspended in Hong Kong, yet the stock surged over 9% in London in early trade. Antofagasta was up 8.5% at 10.00 BST, while virtually all miners were in positive territory on Monday.
On the face of it, Glencore’s restructuring is good news for the FTSE 100 — up 1% in early trade — as well as the broader mining sector.
Just how good is it, though?
Credit Rating Under Pressure
The stated goal is to reduce net debt to “the low $20s billion by the end of 2016“.
As I argued in my previous coverage on 19 August, the speed at which its net leverage was rising was worrisome, and could have determined a less generous dividend policy.
I was not prepared to buy its stock back then, but now it could be a very different story. Let’s delve into the details of today’s release before pulling the trigger!
Good News
Some 78% of the proposed equity issuance is underwritten by Citibank and Morgan Stanley, with the reminder being taken up by management — I am happy with that.
Glencore estimates that about $1.6bn will be saved from the suspension of its 2015 final dividend, which is an obvious target. Some $800m will also be saved from the suspension of the 2016 interim dividend, which also makes sense.
So, the up-to-$2.5bn cash call and $2.4bn of dividend cuts will amount to about 50% of its cost reduction programme.
Uncertainty Remains
The miner expects $1.5bn of additional cash flow from further reduction in working capital management (WCM); there is significant risk with this assumption, given that WCM is almost impossible to model in this environment — but that’s only 14% of the total savings that are being targeted.
However, there’s even higher risk with estimates according to which $2bn will be raised from asset sales (20% of the total savings). In fact, proceeds from divestments should be assumed at zero in this market, in my view.
Furthermore, Glencore said that between $500m and $800m will be generated from a reduction in long-term loans and advances, but it doesn’t state clearly how that is going to happen, aside from a vague statement that refers to “ongoing loan amortisation and various refinancing initiatives“.
Finally, up to $1bn of savings are expected from reduced capex, while additional operating costs savings will be targeted.
There’s more bad news than good news here, in my view, simply because a high degree of uncertainty is associated to over 40% of its cost reduction programme, which suggests that the rights issue should be $2bn higher under a base-case scenario. So, thanks but no thanks: I am not prepared to join the Glencore family just yet.
