Glencore: An Attractive Setup Going Into H2 2021

Summary

• Glencore is performing really well as its main commodity exposure is all doing well.
• The one exception has been coal but that's catching up quickly in the back half of 2021.
• This means cash flow looks like it will increase further at the commodity giant.
• Meanwhile, new management is returning cash through dividends, special dividends, and buybacks.
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Glencore (OTCPK:GLCNF) (OTCPK:GLNCY) is a $62 billion market cap commodity trader and mining firm. The firm provides services (like storage, financial and logistical) to commodity producers. It is also a large producer of commodities itself through owned assets across metals ranging from thermal coal, coking coal and copper to zinc, nickel, and ferroalloys.

The marketing (or trading) business did really well in H1 2021 and contributed an adjusted EBIT of $1.8 billion. The trading business is always important to monitor because its numbers get dwarfed in absolute terms but are very important to the valuation. Trading is much less reliant on a strong economy. Trading can make money in bad markets too and actually help pull production through bad stretches or enable investments in weak markets at low prices.

The production business generated a much higher absolute figure in terms of EBITDA of around $6.6 billion. For the full year, it is not impossible the company will hit something like $11 billion in free cash flow. In other words, it trades at around 6x forward free cash flow.

The company also owns a stake in an agricultural joint-owned company Viterra that it's accounting for under the equity method. Back in 2016, Glencore sold 50% of its agriculture business to the Canadian pension funds CPP Investments and British Colombia Investment Management Corporation. At the current run-rate that should generate something like $500 million/year for Glencore that isn't really reflected in its EBITDA or cash flow numbers.

Seeking Alpha data shows 14 analysts for Glencore and zero revisions of EPS of the upcoming quarter.

Copper, zinc, and nickel are all still quite strong in H2 2020 but coal has been surging H2 compared to H1. Recently going completely nuts:

Interestingly, that's with the second-largest consumer of coal trying to fade high prices by curbing its demand. This has lead to a situation where 16 out of India's 135 coal-fired plants have zero coal stock left. Per that same Reuters article:

according to the Central Electricity Authority (CEA). Over half of the plants had stocks that would last fewer than three days, while over 80% had less than a week's stock left.

Revenue but especially free cash flow attributable to coal should explode for Glencore over H2 2021. Lately, coal has been one of the weaker performers for Glencore in terms of margin but should be about to change in a dramatic fashion:

Image: Earnings presentation cutout

The company recently appointed a new CEO and he's committed to no longer invest in coal. That's not unique within the industry. In fact, Glencore has often been criticized as a laggard in this regard. In the short term, this can lead to surges in coal prices as demand isn't falling along the exact same trajectory. Management has started to significantly reduce the debt towards $10.6 billion and is returning cash to shareholders in the form of both dividends and buybacks. It recently started a buyback program which I think it will finish before February. It is only for about 1% of the current market cap. However, on the last earnings call the CEO has already been teasing shareholders with higher payouts beyond the current period.

and paving the way towards higher payouts as we look beyond the current period as well.

The coal business is in fact so strong that management believes the current record half-year earnings will hold that record only briefly:

So there's going to be a significant pickup in our coal business both into H2 '21, which is why I said, I think our record half year earnings for this particular half is going to be fairly short-lived, with the big pickup second half on the coal industrial side. Our volumes were down period-on-period. We'll see a 47%-53% split is what we're looking at in terms of production. We'll see some pickup clearly there. And then what will come to the market in 3 or 4 months' time in December is more looking into our '22 period in particular where we'll be able to bring in the Cerrejón tonnes as well.

Business is clearly very strong and I don't see any reason for it to decline in the short term. Against the backdrop of the energy transition, I can see a strong market over a longer timeframe.

My biggest fear in such an environment is Glencore going out and throwing its free cash flow at bad assets. But management isn't looking at anything:

And that's where -- that's the area that we want to remain in. Right now, markets are good. We're not looking at anything specifically on M&A. We're focusing on ensuring we run our operations responsibly, effectively and kicking our cash back to shareholders as we stand today.

Better yet management specifically said it is doing the buyback because it sees value:

And that the fact we're doing a buyback, I think, itself should be a signal that we're comfortable doing that. We see value, not so much even cyclically because we'd rather the market have that call, but just a general how sustainability, pricing of cash flows, the sort of delivery of operational performance, the tonnes coming through the African copper business as well, the sort of coal margins, all those things in terms of sort of other valuation factors and discount rates and comfort with different countries.

These are things we're more comfortable clearly taking a call and happy to take a call on. In terms of what copper, zinc, coal prices are, I mean that's something we have a view on, but we're quite happy for the market to make their own call. But I mean the fact we're doing a buyback and then we -- and we won't always be doing buybacks.

The new CEO has also confirmed he continues the Glencore principle of not spending on exploration. Exploration leads to greenfields and greenfields lead to drilling expenses. Once you have a drilling operation it will always want to be drilling.

Valuation & conclusion

To me, Glencore looks quite attractive currently. CRISIL, a unit of ratings agency S&P, expects Australian and Indonesian thermal coal prices to increase due to supply constraints and high demand from China and elsewhere. Free cash flow is already really good. The company is trading on around a forward 6x multiple. The trading operation makes up a substantial portion of free cash flow and deserves a higher multiple because it generates cash in up-and-down markets. The company also owns a stake in an agricultural joint venture that its accounting for under the equity method. At the current run-rate that should be generating something like $500 million/year for Glencore that isn't really reflected in its EBITDA or cash flow numbers. You could argue it is only trading at 5.2x forward free cash flow.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.