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Why I’d buy Glencore plc ahead of Tullow Oil plc

Glencore (LSE: GLEN) is bouncing back stronger than many in the mining sector thanks to its lucrative trading business and faster than expected debt reduction.

Shares in the miner climbed Monday after it again raised its full year EBIT guidance for its trading arm. It now expects to earn between $2.6bn and $2.8bn from the business — up from its previously guided range of $2.4-$2.7bn, and marking its second upward revision over the past year.

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Declining production

Glencore also said production of copper, nickel and oil continued to decline in the third quarter. This contrasts with the recent performance of many of its large-cap rivals, but it reflects the difference in its strategy.

Glencore has idled some of its production capacity in a bold move to balance the market and lift prices. It’s a strategy that is so far paying off as the rising prices for both copper and zinc should more than offset the impact of lower production. And given that the prices of these two commodities have gained more than 20% since the start of the year, this should deliver significant improvements in margin and profitability on its mining side.

Electric cars

Looking ahead, the Swiss-based company is well placed to benefit from the electric vehicle revolution. It is the biggest producer of cobalt, an important component in electric car batteries, and a top-five producer of copper, zinc and nickel, three other metals set to benefit from rising long-term electric vehicle adoption.

The miner is in no hurry to restart previously idled capacity, but a sustained recovery in prices could change its mind. Already, some analysts reckon that Glencore could look to bring back some, if not all, of its idled capacity as soon as 2018.

What’s more, Glencore’s balance sheet is now in good shape. Since reaching a peak of $30bn in 2015, net debt has been cut by more than half to $13.9bn at the end of June. Profits have improved too, with adjusted EBIT in the first half more than quadrupling to $3.8bn.

After a share price gain of 51% over the past year, Glencore doesn’t look cheap at first glance. Shares in the company trade at 13 times its expected earnings in 2018, which is significantly higher than the sector average of 10.4 times. However, this premium could be justified on its better long-term outlook and profitable trading business.

Negative sentiment

Elsewhere, Tullow Oil (LSE: TLW) has hit a rough patch. Shares in the mid-cap oil explorer have slumped more than 40% since the start of the year as the recovering price of oil has done little to help its woes.

Last Friday, Tullow said it failed to strike oil in its latest Turkana oil search off the coast of Suriname in South America. It’s just the latest in a series of setbacks for the Africa-focused explorer, which included earlier exploration disappointments and a $642m writedown on its TEN oil field in Ghana in July.

There’s continuing negative sentiment towards Tullow’s exploration outlook, and analysts have become increasingly concerned about the company’s ability to grow production in order to boost free cash flow and cut net debt. And although net debt has fallen by about $1bn from the end of 2016 to $3.8bn, thanks to a rights issue in April, leverage still seems to me too high for comfort.

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Jack Tang has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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