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As the global stock market rally continues, it becomes harder and harder to find pockets of value. I believe that one such remaining pocket can be found when you look at diversified resource and mining companies with significant exposure to emerging market assets.
When thinking about such companies, most investors immediately think of BHP Billiton (NYSE:BHP) (NYSE:BBL) and Vale (NYSE:VALE) and quickly dismiss them out of fears for a slowing Chinese economy, their significant exposure to iron ore prices and growing caution of a potential iron ore oversupply as various producers have been ramping up production.
I believe that Glencore Xstrata (OTCPK:GLCNF) (OTCPK:GLNCY), a globally diversified mining and resource company led by 57 year old Ivan Glasenberg, is unfairly overlooked despite having a better company culture than most competitors and its management being strongly aligned with the interests of minority shareholders.
Glencore at a glance:
While the above video is a few years old at this point and it was made before Glencore took over Xstrata, massively growing its coal assets, I believe it's still relevant as a quick introduction to the company.
Ironically, while the video was originally made as a part of an anti-Glencore campaign to make the public aware of its opportunistic practices, to me as an investor the video looks like a compliment to the company, showing its importance and influence in the commodity markets.
Glencore Xstrata is a big player in the commodity markets and its $72.7B marketc ap makes it the world's No. 3 resource and commodity company by size, putting it behind BHP Billiton and Rio Tinto (NYSE:RIO) and just ahead of Vale.
The company offers uniquely broad revenue and asset diversification:
Roughly 40% of company revenues come from marketing operations with copper, coal and zinc making up the lion's share of the remaining 60% of revenues that come from asset development and production operations. While China is obviously an important consumer of copper and zinc, Glencore has virtually no exposure to iron ore which makes its rivals more reliant on Chinese growth.
It is also important to note that marketing and trading operations of Glencore provide a source of income that is not reliant on constantly rising commodity prices: they benefit from price volatility (whether prices go up or down) as it allows the company arbitrage opportunities.
Having its own marketing and trading operations makes Glencore a rather unusual commodity enterprise. One of the key benefits is that it smooths out earnings over time and another is that it provides commodity-producing operations and extremely valuable market insight and visibility, allowing the company to adapt and position itself in sync with the changing realities of the commodity markets quicker than the competition.
Comments on company management:
Roughly one-fourth of Glencore Xstrata is owned by company staff and directors. Most notably, CEO Glasenberg holds a 8.3% stake. Glasenberg joined Glencore in 1984 and was named CEO in 2002.
Glasenberg at FT ArcelorMittal Boldness in Business 2013 (FT)
He is a former South Africa and Israel champion race walker and insists on a daily run or swim to keep fit. Today, he is a 57-year-old experienced and battle-hardened executive who I believe still has many years of leadership ahead.
A few choice quotes from the man himself:
- "We also have a commitment, which we've said before, that any excess capital we will kick out to shareholders."
- "We are not a company that is going to grow for growth's sake and keep the money in the company just to build new assets."
- "We are not focused on replacing depleting assets ...if it does not make economic sense and does not give us a return on equity, we will not do it. If our company gets smaller so be it."
With management being essentially business owners as they own a quarter of the company, whoever eventually replaces him will surely be a deserving individual: Glencore has a notoriously cutthroat, competitive, nonstop work culture.
Glasenberg believes this to be smart business: "If I'm not pulling my weight and setting an example" and "traveling 80% of the time," his charges would complain to the board and try to get him fired, and he says "We're all shareholders. These guys below me, they see the CEO taking it easy, it's their money."
A relatively fresh addition to the very top of Glencore management has been ex-BP CEO Tony Hayward. While it can be argued that he did not handle the Deepwater Horizon oil spill PR particularly well while at BP, his deep knowledge of the oil industry at a time when oil seems to be a growing arm of the Glencore business will surely be helpful.
Tony Hayward at World Economic Forum on the Middle East 2008
Hayward joined the board of Glencore in 2011 as an independent director and served as an interim chairman for the past year, before being appointed permanent chairman on the 8th of May.
Declining CAPEX trajectory and improving cost savings:
Glencore has repeatedly blasted its main rivals for their out-of-control CAPEX spending that has been causing oversupply and declining commodity prices. Surely enough, Glencore actually practices what it preaches:
Some investors were understandably disappointed when Glencore took a $7.7B writedown on the takeover of Xstrata, but many people have been seemingly ignoring a big counterweight: the massive amount of synergies and opportunities for cutting costs. Indeed, the cost-saving estimates have been revised up several times now. $2.4B in annual cost savings is going to cover the writedown pretty quickly.
It is also worth noting that the $7.7B impairment charge was more of an accounting issue than a cash-flow one: it was caused by share price movements (the takeover of Xstrata was an all-share deal) since the date the takeover transaction was finalized and the allocation of fair value to Xstrata assets.
Wall Street moving out of metal warehousing:
It has been known for some time now that banks, hedge funds, commodity merchants and other entities are stashing tens of millions of tons of aluminum, copper, nickel and zinc in a hidden system of so-called unregulated "shadow warehouses" that span the globe.
These facilities operate outside the London Metal Exchange system, are not bound by the LME rules that require warehouses holding very large amounts of metal to unload some of it daily regardless of the amount of metal coming in and do not have to disclose their holdings.
Aluminium piled high in a Goldman Sachs warehouse in Detroit (Reuters)
Ownership of these enormous facilities allows commodity dealers to inflate prices as they keep a stranglehold on supply by artificially increasing delivery times. Additionally, their existence can increase volatility in commodity prices when a large amount of metal that was essentially not "on the books" anywhere suddenly gets moved from a shadow warehouse to an LME facility.
The NYT report that brought the situation into the limelight has pushed regulators into action: the DOJ has started a preliminary probe into the metals warehousing industry and the CFTC has subpoenaed several warehouse firms as it conducts its own investigation.
The increased scrutiny had a major impact on Wall Street players: JPM (NYSE:JPM) has now exited physical commodities trading and Goldman Sachs along with Morgan Stanley (NYSE:MS) are now looking to spin off their commodity arms. Who's set to gain from major Wall Street banks exiting this playground under pressure from the Fed? The biggest players that remain: Glencore and Trafigura.
A few words on valuation:
Since the mining industry has seen a fairly large amount of various writedowns over the past few years, I believe that utilizing the traditional valuation metric of trailing price-to-earnings makes little sense. Instead, here is a look at price-to-book and price-to-sales:
|Company||Price to Book||Price to Sales|
* Vale's P/S is inapplicable due to the recent tax judgment distorting the data.
Glencore does indeed look very cheap compared to its peers, but to be fair, not everything is as rosy as it may seem at first glance: Glencore's margins are significantly lower than those of its competitors.
This is caused by the fact that a very significant portion of Glencore's revenues comes from commodities trading, which is a very high volume, very thin margin business. Margins should improve slightly over the next few years as the CAPEX reduction of Glencore is expected to be more significant then that of its peers.
Debt and interest rates: Glencore carries a significant, but not an insurmountable amount of debt: roughly $38 billion. S&P rates Glencore long-term debt as BBB and Moody's as Baa2, placing it at "investment grade," but on the lower end of it. Both have their outlook as "Stable." The company intends to maintain its BBB/Baa2 rating in the future.
Current ratio stands at 1.20, quick ratio at 0.63 and debt/equity at 0.71. The total debt burden is likely to be meaningfully reduced in the near future, as the company intends to use a part of the proceeds from its $5.8B sale of the Las Bambas mine to the Chinese to pay off debt.
It is worth noting that the company is exposed to some short-term interest rate risk as well as its commodity trading operations use leverage.
Geopolitical risks: As a friend of mine put it: "Glencore seems to have very desirable and attractive assets in very questionable jurisdictions."
This is a spot-on assessment: there is indeed plenty of risk when doing business in countries such as Republic of Congo, Kazakhstan and Zambia, but the company attempts to protect itself by having a very diverse asset base around the world and seems to be well-compensated by having higher returns on equity.
The second type of geopolitical risk faced by Glencore is drawing the ire of political leaders of major Western powers by trading commodities and making deals with leaders of questionable jurisdictions. So far, Glencore has managed to expertly avoid getting into any such serious trouble, but there is no guarantee this will continue in the future.
The metals and mining sector has been underperforming broader indices for a number of years now. When the tide changes, Glencore Xstrata with its unique company culture and prudent risk-taking is very likely to lead the pack.
Disclosure: I am long GLCNF. 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.