SAGA OF GLENCORE - CHINESE PLAYING THE VIOLIN AS IT BURNS
By Ruma Dubey
Glencore, one of the world’s largest resource or commodity company is sending shivers down the spine of metal/mining and commodity companies.
The Anglo-Swiss giant is sitting on a debt of over $30 billion and its earnings today are not enough to even service the debt. There was major fear of default at the beginning of the week after which the stock price tanked 29% on Monday and 73% over the entire year. It recouped yesterday after the company issued assurances that there was no fear of a default and it would be selling assets to pare its debt.
Though a default might have been averted for the moment, the sense of unease is too strong to shrug off. What this means is that the company is indeed in dire straits and it would be panic-selling assets, which means it could be selling assets at a loss to bring in funds.
Selling at a loss is also not a new thing for most of the commodity, metal and mining companies. Recently, in June 2015, Glencore sold off its nickel mine in Australia for a mere $19 million. We say, “mere” because it had brought the mine in 2007 for a whopping $2.4 billion. The reason for the sale in losses – when it had purchased the mine in 2007, nickel was priced at $32,000/tonne and today, it is hovering around $11,000.
The company has some $36 billion outstanding bonds and though it retains its investment grade rating, dealers and traders are buying and selling the bonds in cash – its bonds are now quoted in cents v/s its dollar face value and such pricing is typical of junk bonds, which are high-risk for default.
What has happened is that today the company is paying the price for having brought mines at exorbitant prices when the boom was at its peak in commodities. It purchased these mines for billions of dollars and piled up debt. Now commodity, metal, oil, coal, all prices have crashed and it continues to service the debt for those very expensive mines. So on one hand, earnings have dropped and debt is eating away all that it earns.
What about the other giants – BHP Billiton and Rio Tinto? In terms of debt they are much better placed and thus their earnings too more secure. But if the same depressed trend in price continues, they both might not be able to pay any hefty dividend though there is no fear of any default.
For now, Glencore might have well succeeded in assuaging fears and reassuring its investors but the underlying truth remains that if commodity prices sink further, these companies could really be pushed into a very tight corner. Buying over priced assets, depending on debt to fund expansions, possibility of interest rates going up and China slowdown, these metal, mining and commodity companies remain high risk.
In India, investors might do better to stay away for the time being from companies like Vedanta, Tata Steel, Hindalco as they too have similar issues – low realizations and high debt.
PS: The slowdown in China is partly responsible for this crash in commodity and metal/mining prices and ironically, it is Chinese companies which are lining up big time to buy up distressed assets from companies like Glencore at throwaway prices.