Three factors are key for me in selecting stocks to generate serious passive income. First, the yield. Second, the core business. And third, the stock valuation. I do not want my dividend payouts wiped out by share price losses, after all.
Global commodities trading and mining giant Glencore (LSE: GLEN) seems to tick all three boxes for me.
There are risks, of course. It must abide by regulators’ rules, or risk legal problems as it encountered in the past. Additionally, commodities markets may suffer a long downturn or major shock.
Top-tier yield
This said, very few stocks in FTSE 100 yield 9% or over, but Glencore is one of them.
In 2022, it paid a total of 52 cents per share. At the current exchange rate and share price, this gives a yield of just over the magic 9% level.
This was well-supported by a dividend cover ratio of 1.75. Above 2 is considered good, while below 1.5 indicates the risk of a dividend cut.
Despite disappointing H1 results, it still announced top-up shareholder payments of around $2.2bn.
Solid core business
China has been the key buyer for decades of many commodities the company mines and trades. Consequently, a continuation of the economic slump it saw during Covid is bad for Glencore.
However, China’s Q2 GDP showed growth increased by 0.8% in the quarter, compared to Q1. This was better than consensus analysts’ expectations of a 0.5% increase.
On a year-on-year basis, the economy expanded 6.3% in Q2 — significantly better than the 4.5% rise in Q1.
Positive as well were industrial production and retail sales figures released on 15 September that were much better than expected.
Oil is another key business for the company. And it is going from strength to strength, boosted by production cuts from the OPEC+ cartel.
The cartel’s key producers – Saudi Arabia, and Russia – have pledged to continue these cuts until the end of the year. Such reductions are boosters for oil prices.
Attractive valuation
Glencore trades at a price-to-earnings (P/E) ratio of 7.2. This is higher than Kenmare Resources (2.2), but lower than peers Antofagasta (11.1), BHP Group (11.3), and Anglo American (16.5).
Therefore, based on the peer average of 10.3, Glencore looks significantly undervalued to me.
By how much is best answered, I think, by use of the discounted cash flow (DCF) valuation. Given the assumptions involved in this, I do not rely on my figures, but look at several analysts’ DCF valuations.
The assessment for Glencore is between around 32% and 45% undervalued. Taking the lowest of these would give a fair value per share of £6.81.
This does not mean that the stock will reach that point, of course. But it does underline to me that it currently offers very good value.
Added to its attractiveness to me is its 9% yield. This means that £10,000 invested now would make £900 this year. If the rate stayed the same over 10 years, that would add £9,000 to the initial investment. This would exclude tax paid, of course, and share price falls could dent the overall return (although it would also boost the yield).
It all makes Glencore a very interesting prospect to me. I already own stocks in the sector but even with these I may well buy it anyway.
