Glencore shares fell 5% this morning after a Goldman Sachs analyst note cast doubt on the mining company’s ability to maintain its BBB investment-grade bond credit rating.
Here’s the stock:
Goldman analyst Eugene Kim and his team wrote in a note to investors today that if the price of copper fell further, Glencore might not be able to maintain the BBB rating it prizes:
Since announcing c.$US10bn of debt reduction measures on September 7 and completing a 9.9% equity placing, shares have retreated a further 14%. In our view investors are not yet convinced that Glencore has gone far enough to totally allay fears that the industrial assets can service the new lower debt level. Our scenario analysis suggests that using GS estimates for commodities prices and FX rates, Glencore’s IG rating would be secure in the medium term, but our estimates for zinc, nickel and coal prices are higher than spot prices. When we run the same analysis using spot commodity prices and spot FX rates, most of Glencore’s credit metrics would be at the border of required ranges to maintain its IG rating. Finally, a 5% drop in spot commodity and flat FX would see most of Glencore’s credit rating metrics fall well outside the required range to maintain its IG rating, suggesting concerns would quickly resurface. Glencore has a few levers left — further lowering capex, signing streaming deals and releasing more working capital. Recent underperformance suggests that the measures exercised are insufficient and more is needed. We remain Neutral rated but expect continued volatility in the near term.
A spokesperson for Glencore did not immediately respond to a message requesting comment.
On paper, Glencore looks like this, according to its financial statements for the first six months of 2015:
- Revenue: $US85 billion
- Net income: (-$US817 million)
- Cash on hand: $US3 billion
- Current liabilities: $US45 billion
- Non-current liabilities: $US54 billion
- Market cap: $US15 billion
A reduction in Glencore’s credit rating would be disastrous for the company. It would become more expensive for Glencore to service its debts, and it might affect revenues: “Another problem for Glencore is that a credit rating downgrade could greatly affect the company’s trading business,” a note from Jefferies analyst Christopher LaFemina said earlier this month. “A credit downgrade would increase borrowing costs and could lead to some loss of market share in trading as counterparties would likely become more concerned about Glencore’s risk. S&P recently revised its outlook on Glencore from stable to negative. Glencore is still rated BBB by S&P (this is the 2nd lowest investment grade rating), but a downgrade is clearly a risk if commodity prices fall further.”
The company recently issued new stock and a plan to restructure itself in order to reduce its debts. That plan, however, relies on the market prices of metal and commodities such as copper to stay above a certain range.
And since then the price of copper has kept on falling, as this Bloomberg chart shows:
On Sept. 17, copper was trading as high as $US245/lb on COMEX. Since then it has sunk to about $US230.
Until a few days ago, analysts had been bullish about Glencore’s turnaround plan. A Credit Suisse analyst on Sept 7 praised the recapitalisation/debt reduction plan, saying that with copper prices where they are, “under spot prices leverage metrics look set to improve materially and fall well within BBB metrics.”
A note today from Macquarie’s Alon Olsha and colleagues was more positive than their colleagues at Goldman:
GLEN sits higher up in the risk spectrum than either RIO or BLT, but we remain confident that the balance sheet is secure under the new debt reduction plan and that the stock is being mispriced by a market which refuses to consider anything but spot prices into perpetuity.
It looks like copper prices will decide Glencore’s fate.
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