Glencore (LSE: GLEN) announced this morning that it will cut zinc production from its mines by one third, or 500,000 tonnes.
Zinc is currently trading at multi-year lows and the firm says that cutting production now will help to “preserve the value” of the firm’s zinc reserves.
According to the FT, Glencore’s cut equates to around 6.3% of global zinc production outside of China, so it is likely to have a noticeable effect on supply and demand.
Zinc prices have risen by around 6% this morning, while Glencore shares are also up by around 6%.
The share prices of other zinc producers have also risen. Notable among these are Vedanta Resources (LSE: VED), whose shares are up by nearly 10% at the time of writing. Another firm that should also benefit is recent BHP Billiton spin-off South32 (LSE: S32), which also mines zinc. South32 shares have climbed by around 4% so far today.
Are any of these companies a buy, following today’s news?
Glencore
Glencore is under pressure from investors to reduce its high level of debt in the face of low commodity prices. In my view, today’s decision needs to be looked at in this light.
Are the zinc mines affected by the cuts currently operating profitably? Are they generating free cash flow? If the answer to these questions was yes, surely Glencore would be maintaining production to help repay debt.
I suspect Glencore is cutting production in order to improve its cash flow and operating margins. The firm reported an adjusted operating margin of just 3.5% from its zinc operations during the first half of the year. Cutting production at higher cost mines could improve this significantly.
On this basis, today’s move seems smart and cautiously improves the outlook for the firm.
Vedanta Resources
Bosses at Indian miner and oil firm Vedanta must be smiling this morning.
Vedanta owns some of the lowest-cost zinc mines in the world, and zinc accounted for 65% of the group’s adjusted operating profit last year. The boost in zinc prices seen today will help lift Vedanta’s profits.
Vedanta also has high debt levels, but generates a lot of free cash flow. Trading on around 16 times 2016 forecast earnings and offering a 7% prospective yield, I rate these shares as a potential buy.
South32
Earlier this year, BHP Billiton spun off a number of unwanted assets, including its zinc operations, into a new company called South32.
This spin-off came just before the big commodity sell-off, and South32 shares have fallen by 27% since joining the market in May. Today’s news is good for the firm, however, and I believe South32 could be a medium-term buy.
South32 was floated with a minimal amount of debt and is expected to generate net profit of $367m this year, rising to $698m in 2016/17.
The firm’s shares currently trade on just 8.5 times 2016/17 forecast earnings and at around 0.6 times their book value. There’s also a forecast yield for the current year of 2.8%.
