Shares in Glencore (LSE: GLEN) have surged by over 10% today after the company released an upbeat investor update. Glencore said it’s prepared for current and even lower commodity prices through the rapid delivery of debt reduction measures. In fact, it has increased its debt reduction/capital preservation measures to $13bn, which is up from a previous target of $10.2bn. And with the company already having delivered $8.7bn, it appears to be making encouraging progress towards its target.
Furthermore, Glencore goes on to say that it expects to remain comfortably free cash flow (FCF) positive, with more than $2bn of FCF at current spot prices. This is set to be aided by a further reduction in capital expenditure with Glencore now anticipating capex of $5.7bn for 2015 and $3.8bn for 2016, down from previous guidance of $6bn and $5bn, respectively.
Meanwhile, Glencore estimates that 2016 EBITDA will stand at $7.7bn at current prices and with a new net debt target of $18bn-$19bn by the end of 2016 (versus a previous target in the low $20bns), it appears to have a more robust medium term financial outlook than many investors had previously thought.
Of course, Glencore’s business model is highly diversified and its marketing division remains a relatively low risk defensive earnings stream. For example, it’s expected to deliver operating profit of $2.5bn in 2015 with the continued strength in oil and greater contributions from agriculture and metals due to have a positive impact in the second half of the year. Additionally, production cuts among the company’s industrial assets have reduced cash outlay, with those assets being preserved for a potentially improved future margin environment.
Clearly the market has reacted positively to Glencore’s update and in the short run at least, the company’s shares could continue their rise as more investors buy in to an improved outlook for the business. Crucially, Glencore appears to be delivering on its target in debt reduction and this could be enough to significantly shift investor sentiment in the stock for the medium term.
That’s because a key reason for Glencore’s share price fall of 70% in 2015 has been concerns regarding its balance sheet, which didn’t subside even after a $2.5bn share placing. But now Glencore appears to be making strong progress in deleveraging its balance sheet, which is likely to resonate well with the market in the coming months.
Challenges still remain. The company’s marketing division may be expected to be in the black this year but profitability is still under pressure, despite a previously held belief among many investors that commodity price falls would not significantly impact the division’s profitability. And while Glencore may be able to survive further falls in commodity prices, its profitability could decline. Even with reduced debt levels, its headroom when making interest payments may still come under substantial pressure.
So, while today’s news is a step in the right direction and is giving the company’s shares a boost, Glencore remains a relatively high risk option even within the resources sector. As such, and while a price-to-earnings growth (PEG) ratio of 0.8 is hugely appealing, Glencore is likely to remain a stock that will only tempt less risk-averse investors for the very long term.