The last five years have seen almost every major mining company on the London market put in a strong performance.
One glaring exception to this is FTSE 100 firm Glencore (LSE: GLEN), which has fallen by 20% over the last five years — a period when the rival Rio Tinto (LSE: RIO) share price has risen by 45%.
As a natural value investor, I’ve been getting interested. Is now the time to buy Glencore?
Changing the guard
Critics say that its hard-driving trading ethos and big coal business makes Glencore a bit of a dinosaur. They also suggest that ongoing investigations into alleged corruption point to unacceptable standards of corporate governance.
I accept these points, but recent months have seen a number of chief executive Ivan Glasenberg’s closest lieutenants announce plans to retire. Mr Glasenberg himself has said he plans to leave in the next few years, once he’s chosen a successor.
The next generation of top management should be significantly younger, with a long runway ahead of them. I’d expect them to be just as commercially focused, but to have a renewed interest in creating lasting value. In my opinion, they will be keen to avoid a repeat of Glencore’s current legal issues, and are likely to place greater priority on environmental issues.
I’d expect this to lead to a decision to sell or gradually scale back the coal business. Looking further ahead, I think that the company’s substantial cobalt and copper assets should leave it well positioned to profit from growing demand driven by the shift to electric vehicles.
Still a cash machine?
My sums indicate that the company generated free cash flow of about £7.2bn in 2018. Based on the firm’s current market cap of about £38bn, that values the shares at 5.2 times underlying free cash flow. That’s pretty cheap, in my view, and points to the group’s strong cash generation.
One downside of Glencore’s trading-focused business model is that it needs more debt to operate than rival mining groups. However, the company has proved well able to manage this during difficult periods.
Looking ahead, GLEN shares are trading on less than 10 times 2019 forecast earnings, with an expected dividend yield of 5.6%. That could be a decent entry point, in my opinion.
A safer choice?
In contrast to Glencore, Anglo-Australian Rio Tinto mining group ended last year with net cash on its balance sheet. The firm — which makes most of its money from iron ore — paid dividends totalling $9.3bn, or 550 cents per share (c.430p) for 2018. That includes a $4bn payout reflecting cash received from asset sales, including its remaining coal operations.
Last year could turn out to have been a record year for profits too. Rio reported an after-tax profit of $13.6bn for the period. Analysts are forecasting a figure of about $10.5bn for 2019, and $9.1bn for 2020.
These estimates may change — they’ve risen by about 10% in the last three months alone. However, I think it’s worth viewing last year’s performance as a possible peak.
For this reason, the stock’s 2019 forecast price/earnings ratio of 9.2 and dividend yield of 6.2% may not be quite as cheap as they seem.
In my view, the Rio share price looks fair based on recent performance. However, I plan to wait for an opportunity to buy when this stock has fallen out of favour with investors.
