Plummeting commodity prices and sky-high debt have caused shares of Glencore (LSE: GLEN) to drop 50% over the past 12 months. And despite a strong year-to-date rally, I expect further pain to come for the diversified miner and trader. The main reason I’m staying away from Glencore is slowing demand from China for the commodities that were necessary for its decades-long investment binge. Now that the government is trying to wean the economy off of an over-reliance on building roads and airports to drive GDP growth, the future for commodities looks increasingly dim.
Furthermore, Glencore has to deal with a veritable mountain of debt. And while the company has done good work in chipping away at it, even hitting year-end targets will leave the company with around $17bn to $18bn in net debt. While this isn’t as bad as some smaller competitors, it’s still two times 2015 EBITDA. And with shares trading at a pricey 33 times forward earnings, the market has already priced-in significant profit growth as the company divests non-core assets. With subdued global demand for its key products ahead and significant debt to pay down, I won’t be buying Glencore shares any time soon.
The debt issue
Utilities have long been held up as some of the safest of equity investments due to their steady revenue and government oversight. However, this month’s £700m equity placement by Centrica (LSE: CNA) shows that even utilities can find themselves in hot water. Centrica’s problem is the company’s £4.4bn in net debt, which is twice last year’s EBITDA. While all utilities rely on cheap loans to finance activities and support steady dividends, debt of this level raised worries that the company’s debt could lose its investment grade status.
The £700m placement should forestall these worries for the time being, but the company’s future is cloudier than that of many utilities. This is because even after cutting dividends last year, they were only covered 1.4 times by earnings. This is around the same level as National Grid, but Centrica doesn’t have the growth prospects of its larger rival, creating questions over the possibility of future dividend growth. Centrica is also struggling with organic growth and has turned to acquisitions to improve its top line, which combined with high debt levels and a history of dividend cuts leaves me looking at other utilities.
A risk too far?
Oil & gas producer Genel Energy (LSE: GENL) avoided many of the mistakes that its over-leveraged, wildly-high-cost-of-production rivals made during the boom years of $100-plus crude. However, Genel is still facing enough problems to make me wary of buying shares at this point. The largest issue facing the company is a series of downgrades to its proven & probable reserves earlier this year that resulted over $1bn in impairment charges.
Aside from lower-than-expected reserves, Genel’s location in Iraqi Kurdistan also raises issues. The Kurdish government, beset by well-known security problems and payment disputes with the Central Government, was forced to cut back on payments to oil & gas producers due to liquidity issues in the past few years. Although the government has made monthly payments to Genel since September, the company was still owed over $400m at year-end. While this problem is improving, the region remains unstable and the possibility remains that the Kurdish government could once again be forced to cut payments to Genel, a situation I find too risky for my portfolio.
