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.
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!
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.
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.
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Alessandro Pasetti has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.