Glencore’s stunning comeback

The surprise $1bn dividend undertaking announced by Glencore last week gives firm notice that – as far as the worthies of the Swiss company are concerned – its part in the four- to five-year slump in the commodities market is officially over.

Analysts liked the dividend announcement. “Glencore’s Investor Update call on December 1 confirmed what we already knew – the company has made a stunning comeback from a position of unfamiliar weakness just over one year ago,” said Macquarie Bank.

“The decision to reinstate the dividend in 2017 therefore came as little surprise but the innovative payout policy announced could support handsome distributions to shareholders under the right conditions,” it added.

The innovative payout structure is that Glencore will supplement a $1bn dividend promise in the 2018 financial year with 25% of free cash flow from its mining or industrial assets. It will pay a straight $1bn in the 2017 financial year.

The main thesis of Ivan Glasenberg, CEO of Glencore, is that supply in certain commodities is constrained; zinc, for instance. Second, he thinks Glencore is able to withstand another sudden correction: the balance sheet is strong with its net debt-to-pre-tax-earnings ratio – one used by analysts as a guide of exposure – is unlikely to move beyond two times.

Third, Glasenberg believes the company’s assets will deliver a margin regardless of economic conditions. “New supplies on our chosen commodities are tight and we feel very comfortable. We’ve also spent $39bn between 2009 and today rebuilding the asset base of the company,” he said.

“This was important as it was the first of the Big 4 [Rio Tinto, BHP Billiton, Anglo American and Glencore] setting the stage for the 2017 financial year,” said Goldman Sachs in a report.

Analysts agree the market is looking better. “Balance sheets have been repaired, costs have been cut and capex pared back,” said Investec Securities. “As a result, most mining companies are now in good shape to face whatever 2017 brings,” it added.

Glencore is hoping its credit rating will also be restored: another mining company, Anglo American, saw its long-term credit rating increased by Standard & Poor’s, and yet remnant caution exists. “That said, we believe that the industry should now take a breath, and reflect on the lessons of the very recent past, before rushing headlong into the new year,” said Investec Securities. 

Macquarie Bank, however, thinks that the potential for Glencore’s dividend to shoot the lights out is very real. Based on its projections for commodity prices, and Glencore’s ability to exploit them, the Swiss group could easily keep its debt at 1 x pretax profits and payout 80% of free cash from its mining assets (versus 25% Glencore said it would pay).

“The free cash flow payout ratio would result in the dividend rising to 18 US cents in 2017 and between 28 and 29 cents in the 2018 to 2020 financial years, implying a dividend yield of 5% to 8% over the next few years,” it said.

Citi has upgraded Glencore to a buy for 2017, but it also comments that quality mining stocks in general are probably worthy of investment if only because the sector has fought back so well this year. 

“The metals and mining sector has outperformed every other European sector in 2016,” it said, pointing to an increase in its FTSE 100 weighting from sub 4% a year ago to around 7% today. “We think the mining sector is now back to a sufficient size which can’t be ignored by fund managers, which raises the big question as to what to do in 2017,” the bank said.

“On our calculations under spot commodity prices this would suggest a minimum variable dividend of about $1.7bn, which in addition to the $1bn of fixed base implies a total 2018 dividend of about $2.7bn, implying a dividend yield of 5.4%,” said Citi.