FTSE 100 firm Glencore (LSE: GLEN) describes itself as “one of the world’s largest global diversified natural resource companies and a major producer and marketer of more than 90 commodities.” If you are going to invest in the resource sector, I reckon it’s a good idea to go for a well-diversified firm so that you can iron out the risk of being exposed to just a few commodities. Some firms, for example, specialise in just one commodity such as copper, perhaps with a little bit of residual gold production, but investing in a firm like that can involve more risk.
Glencore is a little different compared to other big mining firms such as BHP Billiton and Rio Tinto because it has a big commodity marketing division running alongside its down-and-dirty industrial activities. Last year, around 35% of the firm’s earnings before interest and tax (EBIT) came from its marketing operation and the remaining 65% from the industrial business. Overall, 71% of EBIT derived from metals and minerals, 27% from energy products and just 2% from agricultural products. So, although the firm is diversified, there’s still a big dependence on the metals and minerals market, and Glencore is active in zinc, copper, lead, alumina, aluminium, ferroalloys, nickel, cobalt and iron ore. Operations include smelting, refining, mining, processing and storage of the relevant commodities
At first glance, the financial indicators look attractive. With the share price close to 304p, the firm is valued around eight times anticipated earnings for 2019 and the forward dividend yield sits just over 5.8%. But City analysts following the company expect earnings to remain broadly flat in 2019 compared to the current year, and that could be one reason that the share price has slipped back around 25% this year. But Glencore has just extended its share buyback programme by another $1bn, which could help to support the share price in the short term.
Is that fat dividend risky?
We could buy some of the shares to collect that fat dividend but I think that would be risky. With growth in earnings stalled, it is beginning to look like earning might have reached a plateau and that worries me. The commodities sector is known for its cyclicality and the big risk, as I see it, is that the current level of earnings could prove to be another peak. If it is, the next move in earnings could be down. We only have to look back as far as 2015/16 to see what happens when revenue, earnings and cash flow dive – the share price and dividend were crushed and I fear that something similar could happen again.
In hindsight, the best time to have bought shares in Glencore recently was at the beginning of 2016 in order to have ridden the cyclical up-leg that followed. But that was psychologically hard to do when the firm looked like it was on its knees and the outlook was murky. However, I’m avoiding the stock now because I think it is risky. Instead, I believe my money would be better invested if I chose a diversified, low-cost FTSE 100 tracker fund instead.
Kevin Godbold has no position in any of the 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.