When something is called junk, chances are you probably don’t want to buy it.
Traders in Glencore bonds have stopped using the rate of interest to describe how much they’re worth, and are quoting prices in cents on the dollar of face value, according to a report in the Financial Times on Thursday.
The change usually means the traders think some kind of default on the debt is possible and consider the bonds to be junk.
Glencore has a huge amount of outstanding debt. The company has about $US36 billion (£24 billion) outsanding in bonds overall, of which around $US6.5 billion (£4.3 billion) becomes due next year.
Here’s the table from Citi analysts led by Heath Jansen:
Traders are worried that the company won’t be able to pay back the bonds and all the other types of debt. The debt maturing in May 2016 is trading around 93 cents on the dollar, according to the FT, giving an effective annual yield of 13%.
That is absolutely huge, especially in an era of permanently low interest rates brought about by central bank easing.
It’s almost 10 times the yield of the Bloomberg European investment grade corporate bond index, which is a benchmark for how valuable the top performing corporate debt is considered to be.
It’s the kind of pricing that screams high risk. The bond investors fears are driven by the commodity price crash stifling the company’s cash flow, especially in copper revenues.
That’s important for Glencore because if it needs to raise any more debt, then it will have do so at the market price. And 13% just isn’t sustainable.
But it’s an absolutely great for an investor with the stomach for taking a contrarian view.
Glencore has about $US6.5 billion in cash and almost double that in available liquidity according to Citi. The company doesn’t need to raise money on the market and doesn’t need cashflow to pay those bonds back because it has the cash ready.
The other loans are actually lower than most people think and can be rolled over until 2017 at a low cost because of Glencore’s large number of relationships with banks.
According to analysts at Bank of America Merrill Lynch, the $US9 billion revolving loan due next year can be rolled over to 2017 for as little as 0.25%, leaving the Glencore balance sheet in a better position to pay back the 2016 bonds.
So that 13% could be the easiest money you make this year. Of course, if the bond traders turn out to be right, it could be a disaster.