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Morningstar | Glencore Benefiting From Elevated Coal Prices; GBX 250 FVE Unchanged

Glencore’s 2018 net profit after tax fell 41% to USD 3.4 billion, or USD 0.24 per share. Several significant items detracted by USD 2.4 billion in total. The main expense was USD 1.6 billion of impairments relating to the Mutanda and Mopani copper assets in Africa. Glencore cited increased costs and regulatory and operational challenges as the drivers. In part, the impairments reflect Glencore’s exposure to higher-risk locales. Net of significant items, adjusted net profit rose 5% to USD 5.8 billion, or USD 0.40 per share. This was weaker than we forecast, with the fourth-quarter commodity price downturn detracting from mining and trading.

Adjusted EBITDA rose 8% to USD 15.8 billion. The firms’ industrial division, which captures the mining assets, delivered 15% higher EBITDA of USD 13.3 billion. Coal was the primary driver, rising 48% to USD 5.3 billion, primarily with buoyant prices but also with the assets acquired from Rio Tinto. Metals and minerals was essentially flat, with higher costs offsetting much of the benefit of higher prices. Marketing EBITDA, which covers the firm’s commodity trading operations, declined 17% to USD 2.4 billion. Earnings were affected by unfavourable legacy alumina pricing and the impact of cobalt inventories marked to market. The cobalt price has halved since October as recent high prices created incentives for new supply. New-generation batteries are also using less of the previously expensive cobalt.

We maintain our GBX 250 per share fair value estimate and reiterate our no-moat rating. While positive on the outlook for the firms’ trading arm, it’s difficult for mining companies to carve out economic moats. Earnings from mining are more than 80% of Glencore’s EBITDA. The company only just earned its cost of capital in 2018 despite relatively favourable prices. As prices normalise, returns should moderate. Overvaluation primarily reflects copper, coking and thermal coal prices which are well above our long-term assumptions.

Glencore has made only relatively minor changes to production guidance. Copper has reduced for the next few years. Glencore expects to only mine about 100,000 tonnes a year of copper from Mutanda in Africa, half the historical amount. Still, the company expects copper output of about 1.5 million tonnes a year to 2021, up 3% on 2018 levels. Copper cash costs are expected to average USD 0.92 to USD 1.25 per pound in 2019 versus USD 1.04 per pound in 2018. The upper end of the range has increased to reflect the lower Mutanda volumes and the expected lower by-product credit from reduced cobalt sales volumes and prices. Much of the firm’s cobalt is being stockpiled as it’s not saleable in its current form. Glencore will undertake further processing to remove radioactive contaminants. The excessive cobalt inventory build is expected to normalise in 2020.

Zinc cash costs are forecast to rise to USD 0.36 per pound in 2019 from USD 0.24 in 2018 with lower copper and lead by-product credits and higher smelter charges. The company expects nickel cash costs to nearly double to USD 3.79 per pound from USD 2.11 per pound in 2018. The bulk of the increase reflects the ramp-up of Koniambo. Unit costs will be elevated until the mine reaches full capacity. Coal unit costs of USD 48 per tonne are expected to be broadly in line with 2018 levels. Production is set to rise 12% to 145 million tonnes with a full year’s contribution from the acquired Rio Tinto mines.

Glencore tends to carry much more debt than its peers to support its commodity trading activities. That said, the balance sheet is relatively robust. Net debt increased 44% to USD 14.7 billion, primarily reflecting USD 3.9 billion of acquisitions. The ex-Rio Tinto coal assets were the prime driver. Debt remains within Glencore’s USD 10 billion to USD 16 billion target range. Net debt/adjusted EBITDA of 0.93 is relatively comfortable but somewhat flattered by the current favourable commodity prices. Glencore expects to keep net debt/adjusted EBITDA around 1.0 at this point in the cycle. If necessary, debt will be repaid if commodity prices fall to maintain financial strength.

Glencore returned distributions of USD 2.75 billion, or USD 0.20 per share, to shareholders in 2018. For 2018, the company expects further distributions of USD 0.20 per share. Like peers, the balance sheet is allowing a greater proportion of elevated free cash flow to be returned to shareholders, supported by favourable commodity prices. In addition, the company expects to buy back USD 2 billion of shares with a further USD 1 billion contingent on market conditions, or USD 1 billion of planned asset sales.