Glencore: Q2 Production Report Analysis

Summary

• Glencore reported mixed results compared to Wall Street analyst estimates.
• It also reported strong performance of coal and marketing.
• It has higher FCF coverage than peers, and the dividend yield is only second to Rio Tinto. We confirm our buy rating.

Schroptschop

In this earnings season, we are closely following the mining sector. For our readers that want to deep-dive and compare the quarterly production report, below is our coverage universe:

• Rio Tinto (RIO)
• BHP (BHP)
• Anglo American (OTCQX:AAUKF) - (Initiation of coverage)

Moving on with Glencore (OTCPK:GLCNF) (OTCPK:GLNCY), the company plans to report the full result disclosure on the 4th of August. For the year, the other important catalysts are going to be the UK SFO hearing investigation scheduled for the 2nd and 3rd of November as well as the ongoing Swiss OAG investigation.

As a brief recap, our buy case recap was based on the following key takeaways:

1. Glencore's commodity mix. We like the diversification but also the company is exposed to value-added metals for EVs and the energy transition;
2. Higher than expected cash generation thanks to the coal division (and the marketing ones);
3. ESG's recovery story which was based on resolving pending litigation, but especially trying to convince Mr. market of coal optionality.

Q2 Production Results

Moving on with the Q2 production report analysis, as Glencore stated: "production was mixed period-over-period (5 commodities up and 5 down in the table below)". Looking at the Wall Street consensus estimate, Glencore's output was weak with unexpectedly lower guidance on copper. The mining giant has also highlighted the fact that the working capital requirement will increase due to marketing and higher industrial production.

Glencore Q2 operational review

Source: Glencore Q2 press release

Regarding the main commodity results, below is Mare Lab evidence's analysis:

• Zinc - the commodity was 3% below consensus. This was a result of COVID-19 absenteeism (as already happened in Rio Tinto and BHP);
• The copper division missed Wall Street analyst expectations by more than 7%. As we already mentioned, the 2022 outlook was cut by 5%. This was driven by the Katanga site with geotechnical problems and the Mt Isa site which delivered lower output (again for COVID-19 absenteeism);
• Coal was again a miss. Looking at the numbers, the company delivered a -10% on the output performance. In South Africa, there was a supply chain constraint that reduced production. Adverse weather conditions lowered again the end output. Despite that, Glencore coal guidance was left unchanged.

In a similar order of magnitude, realized price in copper, zinc and nickel was 8%, 6% and 4 % respectively below consensus. This was partially offset by the higher prices of coal.

Glencore realised price and production outlook

Source: Glencore Q2 press release

Conclusion and Valuation

Glencore's portfolio optimization has also moved on. The company sold its 6.4% equity stake in Yancoal for a total consideration of $293 million. In July, the mining conglomerate also completed the BaseCore Metals sale for another $545 million. Based on our internal model and adjusting our numbers with the latest consideration, we derive a target price of £5.5 from our previous valuation of £4.65. This is consistent with our valuation methodology used for our mining coverage. Indeed, we derive our valuation based on a 50%/50% blend of EV/EBITDA on 2023 numbers and thanks to a NPV analysis.

Despite the analyst expectations, the coal division coupled with the marketing is an ongoing cash cow. In 2022, we estimated that the two divisions will generate 32% of Glencore's market cap. We should also note that the marketing business is a real key takeaway compared to its closest peers (except for Anglo American) and the current commodity market volatility will drive the underline profitability.

Adding more color to our analysis, we should say that Glencore has one of the highest dividend yields within the sector and is well covered by its free cash flow generation. Indeed, in 2022 and 2023, our internal team is forecasting a yield of 15% and 14%, which is second only to Rio Tinto. However, thanks to the marketing division, Glencore has a 1.9x FCF cover resulting in a more defensive position than Rio Tinto's FCF cover which currently stands at 1.2x.

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.

Comments

[js.andrew]

Thanks for the article; is the 15% yield Free Cash Flow or Dividend?

[Price Holland]

Thanks for the informative article.
With a dividend of 26 cents and a dividend yield of 2.3% I believe there are many better alternatives in the Basic Materials industry if you prefer a high dividend yield.
Please let me know where your statement that 'Glencore's dividend is only second to Rio Tinto' is based upon?
For example BHP has a significant higher dividend yield.

[Wulumuqi]

@Price Holland Consensus estimates are 11.7% yield for 2022 and 10.6% for 2023. www.marketscreener.com/... In this article they are forecasting 15% and 14% respectively which is even better.

[Bodipb]

$20 please.