Glencore: Little Progress Deleveraging Hampers This Contrarian Opportunity (OTCMKTS:GLCNF)

Introduction

The recent turmoil in global financial markets has seen the share price of the Anglo-Swiss mining giant Glencore (OTCPK:GLCNF) sink to lows not seen since the hectic days of 2015-2016. During this period of time, there were concerns that this industry juggernaut may be heading for bankruptcy amidst high financial leverage and plunging commodity prices. Whilst they were able to avoid this terrible fate, given their share price is once again trading at these arguably distressed levels, it is worthwhile to review their financial position. Selecting investments in the mining industry during a downturn can be very profitable and a great contrarian way to make sizable profits, but if the company does not have adequate financial strength, this can end painfully.

Cash Flows & Debt

Thankfully the graphs largely speak for themselves, with the first two graphs included below summarizing their cash flows and debt from the last seven years:

Glencore notes 1

Image Source: Author

Before analyzing their financial position, reviewing their cash flow performance is important, as it provides context regarding the insights into the quality and efficiency of their assets. It was quite surprising to observe that throughout the last seven years, they have produced free cash flow during all years. The ability to consistently generate free cash flow, even at low levels during downturns, is immensely helpful and reduces any pressure on their liquidity. When looking towards the future, their free cash flow naturally remains virtually impossible to accurately predict, due to the combination of volatile commodity prices and their extensive marketing operations. Their historical performance nonetheless still indicates that there are reasons to remain optimistic despite many of their core commodities plunging, such as copper.

Glencore cash & debt

Image Source: Author

Following their aforementioned close call with bankruptcy, as expected, they made reducing their net debt a goal. Despite initial success that saw their net debt decrease an impressive 25.74% between the end of 2015 and 2016, it has subsequently crept higher and is now only down 15.00% by the end of 2019. Whether this is a reason for concern depends on the financial metrics subsequently discussed; however, on the surface, it indicates they have made only marginal improvements. Thankfully they retain a modest cash balance, which after being combined with their consistent free cash flow, further increases the apparent strength of their critically important liquidity.

Financial Position

Since their net debt has only decreased modestly, it is especially important to consider their financial position through analyzing their financial metrics. The graph included below summarizes their financial position from the last three years:

Glencore leverage ratiosGlencore notes 2

Image Source: Author

After comparing their current financial metrics to their equivalent results from 2015, it further indicates that overall they have only made marginal progress increasing their financial strength. On one hand, their gearing ratio and net debt-to-operating cash flow metrics have actually slightly worsened; however, the difference is small and counteracted by their lower net debt-to-EBITDA and interest coverage metrics. Considering their core commodity prices were actually higher on average during 2019 versus 2015, see the table included below, this is underwhelming and thus further raises questions of whether they have made any progress increasing their financial strength.

Commodity Prices

Image Source: Author

Date Source: Glencore’s 2015 Annual Report & 2019 Annual Report.

Thankfully their current ratio of 1.06 further supports the strength of their liquidity, which is particularly attractive at the moment, since there has been increased criticism of companies that are heavily reliant on credit facilities. Given their moderately high leverage, if it were not for this good liquidity, there would be serious concerns regarding their ability to navigate these times without a large raising equity. Once all of these metrics are considered, it appears that they entered this downturn without making any significant progress to strengthen their financial position and thus their shares carry above-average levels of risk.

Given the high geopolitical risk of the jurisdictions that they frequently operate across, their risk of sudden black swan events occurring will always remain elevated and thus could cause their financial position to deteriorate rapidly. Whilst it alone would be unlikely to bankrupt the company, a very recent example is their dispute with the government of Zambia. Although this risk is common across the mining industry, it nonetheless still further decreases the overall attractiveness of their shares.

Conclusion

Even though they have made changes to their portfolio of assets across the years, their financial position remains very important when determining whether they can navigate this downturn. It would have been more reassuring to see more significant improvements across their net debt and associated financial metrics. Alas, this has not been the case, and as a result, they have entered this downturn with questionable preparation. Given their history on navigating the last downturn and their good liquidity they should still outlast this downturn if a recovery eventuates within the next one to two years, but unfortunately they are a risky option for contrarian investors. When all of these factors are combined, I believe that a neutral rating is appropriate, largely due to the associated risks and the uncertainty surrounding the timing of when operating conditions will recover.

Notes: Unless specified otherwise, all figures in this article were taken from Glencore’s Annual Reports, all calculated figures were performed by the author.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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