Mark Ingham: Running rule over hot stock Glencore – has it risen too far?

LONDON — The longer one watches investment markets, the more you’ll realise that a significant premium should be put onto independent thought. And in that category, Mark Ingham stands out like a beacon. After a distinguished career within the system, he went solo in 2003, long before it became popular. Having long ago been freed from informal restraints that control corporate relationships shows. Ingham recently invested his considerable talents into analysing Glencore, the Swiss-based mining house run by South African Ivan Glasenberg. As the stock has been a star performer in the Biznews SA Champions portfolio, I was obviously keenly interested in swapping notes. Mark duly obliged. But even though valuations differ, our long-term conclusions don’t.  – Alec Hogg    

Mark, your most recent most recent research report Glencore – we like the company and own it in the Biznews SA Champions portfolio, but I see that your fair value for Glencore is a little lower than mine. It’s in fact, below where the shares are trading now – is this telling us that perhaps the share price has got a little ahead of itself?

Alec, yes. I think it’s been on a bit of a tear of late. I tend to watch the price in London. For obvious reasons, the price on the JSE is pretty much a reflection of that and the bulk of the trade in the stock market takes place abroad anyway. It’s hard to believe that it wasn’t that long ago, in 2016, when you could have picked this thing up for 80 pence. It’s not trading at £3.50, which gives it a market cap of approximately £50bn, which is a fairly chunky number. When I do the evaluation it would probably be, particularly in a case of a mining company, in this case rather a hybrid miner and a commodity trader – I would use a DCF. I’ve got to be true to that and on that basis, in the last valuation I did, I came to $3.84, which at the time was just under £3.00 or approximately R52.00 on the JSE. As you correctly say, Alec, it’s moved up a bit since then but I’ve covered mining companies long enough to know that you can have quite a roller-coaster on these things so, I tend to err on the side of conservatism.

And nothing wrong with being conservative in investments. The big story though with Glencore for some of us, is its exposure towards electric cars, and this was a point that Ivan Glasenberg, the CEO, made very forcefully at the AGM earlier this year. Where in fact, his whole presentation was all about why they’ve positioned the portfolio in such a way as to benefit from the boom in electric cars into the future. It seems like that message has certainly influenced investor perceptions.

I think so. I think Ivan in his discussion over the results, referred to the ‘greening’ situation in their commodity base. You’re looking at copper, cobalt, and nickel, all of which would benefit from this push to electric vehicles. We don’t particularly know at this stage, the degree to which the electric vehicle will make inroads. Certainly, it’s a fraction of the total vehicle market at the moment and it has been growing quite sharply. They talk about 2 million electric cars at the moment. That number could, of course increase quite sharply. I think history teaches us, Alec, that when it comes to change of the magnitude that we’re seeing in the world at the moment, I think people predict the short-term impact perhaps rather greater than what the short-term impact would rather be. I think while we may overestimate the short-term, we tend to underestimate the long-term effects, and I think it’s quite clear that in the longer run there’s no doubt that this is going to be a real shaping influence on the way we travel, and this is the one company that’s very well positioned for that.

Indeed it is and it’s interesting you make that point because the conversation I had on Friday over lunch, with Barry Davison, who I’m sure you’ll recall for many years is the doyen of the platinum industry. He’s retired and 72 now but he was talking about one of your favourite stocks, Sibanye’s acquisition of Stillwater and saying, ‘yes, we know all the numbers for the electric cars but in the short term there’s no question that Palladium is still going to be very much required by petrol vehicles.’ But going back a little bit to what you were saying about the interim results, they were particularly good, these ones from Glencore. 

Swiss commodities trader Glencore’s logo is seen in front of its headquarters in Baar, near Zurich, in this February 6, 2012 file photo. . REUTERS/Romina Amato/Files

Yes, I think it surprised quite a lot of people. It wasn’t that long ago when analysts and bankers were telling them to get rid of debt and in a short space of time the whole commodities complex has bounced back quite a bit but I think beyond that and to give management their due. I felt that perhaps people were a little too pessimistic, going back a couple of years about the outlook for the group but management took it on board and they cut their coat according to the cloth available, at that time. Which meant that they divested of certain assets or sold down some of their assets to bring in joint venture partners, such as in agriculture, and as a consequence of that, together with a more buoyant commodity market, it resulted in their balance sheet being in extremely good shape. As a result of that it means that the company has met its gearing targets well ahead of time so, we had a net debt situation of about $14bn at the half-year. A very good interest cover and the possibility of them paying out a stronger shareholder dividend in the future because of the likelihood that the cashflow position is going to be quite robust for the next few months. The adjusted EBITDA for the group, for the period, was up 68%, which is a very strong performance.

It certainly is, and then if you add on a higher dividend. How much higher might that dividend be and is it because they’ve managed to get their debt down to levels that you’d be happy with?

Yes, they did declare a $0.07 cents dividend last year payable in 2 transfers and in my latest numbers, which I think you’ve seen, Alec. I’m looking at them getting say, around about $0.33 odd at the headline level this year, which would translate into about $4.9bn, let’s call it $5bn bottom line. That would be assuming that operating EBITDA is approximately $14bn. That could mean that your divvy could be as much as $0.17, which would be a very chunky dividend. They’ve been a little cautious on managing expectations around the degree to which they could return cash. I think they do see opportunity and I think they need to keep their powder dry, to leverage on that opportunity and I think given the balance sheet that they have at the moment, they’re probably in a better position than many of their peers. So, whilst there is the possibility that there could be further pay-outs, maybe a share buyback, or maybe a special dividend. At the moment, I’m not factoring that in. I’m just assuming that they will pay a dividend that squares with the earnings performance.

Now, from an investment point of view the case is pretty compelling but from a broader perspective there are flags that are being waved. First of all, the company was started by a fugitive from justice called Marc Rich, and there’s always concerns when that’s the legacy. But they also operate in very dodgy locations and over the weekend there was an amazing piece in the Financial Times of London, in their magazine, which unpacked the shenanigans going on in Kazakhstan, between a Zuma-type figure, who runs Kazakhstan but is way beyond what SA accuse Jacob Zuma of, and Glencore has got big interests in Kazakhstan, not least it’s zinc interest. It does operate in dodgy locations and is that a risk that one, (a) needs to take cognisance of and (b) is it one that might, at some point, blow up in their faces?

Mark Ingham

True, and talking about that particular country, Kazakhstan, they’ve already had a financial effect given the fact that the currency fell by about 50% for their first-half results. So, that did have an impact on the reported numbers there. I think in the mining arena one does find that companies end up in questionable places. At one point even, SA was considered a prime mining location and look where we are today. I think a company like Glencore does have fairly stringent governance requirements. You can’t always choose your geology and sometimes the geology is in a place whose politics you may not agree with but I think it would be a stretch to say that Glencore would behave in a way that was not in keeping with a London listed company and with all the government’s requirements and, in fact, the oversight that a company like this has.

I’m not convinced that that would be sufficient if there were problems there to upset the whole applecart. It’s a well-diversified clutch of assets, Alec, as you well know. Both on the industrial side and the marketing side. The marketing side particularly, is a very good underpin to profits. That’s more the trading business. The Kazak business, and in the overall scheme of revenue and EBITDA, it would be important but I think we shouldn’t overestimate the impact.

I wasn’t suggesting that Glencore would be stupid enough to get themselves into governance issues but as we’ve seen in Zimbabwe. When you have these strange governments in control, or strange dictators running countries, they do some pretty weird things. Only ask Impala Platinum on what’s happening with their platinum operations in Zimbabwe, but to put that to one side. The commodity prices that have a huge influence on Glencore’s health have really turned for the better in recent times. Do you take that into account when you look at the valuations and your assessment of a company like that? In other words, with those improved commodity prices, do you look at them and say, ‘they’re at a more, normalised level now or are you concerned that they’ve run up so fast?’

Alec, I think that’s a good point. The whole commodities complex is increasingly driven out of the East, and particularly China. In a number of commodities, you’ll see that China accounts to 40% – 50% of global demand. I think, per your point about the electric vehicles. If you look at cobalt for instance, and even copper, that’s been rising. We are seeing tentative signs of more on-shoring, when it comes to manufacturing. So, I think that the demand for commodities is not going to diminish materially any time soon. It will be subject to the usual ups and downs, it is a cyclical area, and I think most analysts tend to take the midpoint.

If you had to price Glencore at spot, Alec, at the moment then you could easily justify prices at least at these levels, certainly even more but I think when I do the modelling, I have to take it through the cycle view and, as a result of that, it would tend to, as I say, err on the side of caution. So, for argument’s sake, if you take copper. I’ve got a price of $2.59 per pound in 2017, and then pretty much keeping at that level for the next 2 years. Zinc will have increased from 88 cents to, it was close to 93 cents last year. I’m looking at about $1.29 this year, and then up slightly before coming back. Nickel too, it’s come off its levels in 2015. I’m looking now at about $4.40 a pound, and then up to $4.70. Lead tracking very much in line with where we are at the moment.

Cobalt too has had a particularly good run. We’ve seen cobalt go from an average of $13.00 a pound to a level of $25.00, which is the number I’ve put into my model for this year. Gold is tracking fairly flat, as is coal, and I’ve got oil at about $56 so, the numbers going forward are not dramatically out of kilter with the averages that we’ve seen in the last year or so, and all that we do know is that if the pricing firms further from here, that will just add to the cash flow benefit for the company and strengthen the financial position even further.

So, taken together, we do have Glencore in the BizNews SA Global Champion’s Portfolio, which is for JSE listed companies, run by South Africans who operate in the global arena. We’re happy with having it in there. Are you telling us to be careful of this one? That maybe it’s time to be considering reducing the investment or are you happy that we can stay with it?

I think one has to be cautious with mining companies. Typically, I’m of the view that one probably needs to, not necessarily take a ‘buy and hold approach.’ Timing, as you well know, Alec, in getting into mining is very important so, you’ve got to have a pretty good sense of the fundamentals that are driving the business. If you can satisfy yourself around that and the share price squares with your conviction then there’s no doubt that mining stocks can have a key role to play in your portfolio. They can also give you that alpha at certain times and I think we’ve seen that in recent months, where a number of commodity counters have outperformed quite nicely. Some haven’t but I think Glencore, certainly from a timing point of view, if you go back to where it was. The share price has more than trebled in the last year/18 months, or so, and so that’s a really nice alpha.

It means that the share price at these levels is getting back to the levels we saw through 2013/14 and part of 2015. So, given the dynamics affecting the commodity complex at the moment, Alec, I feel very comfortable with that view that you have. I would however, look at probably lightening. If the portfolio weighting perhaps started to nudge up a bit too much, but at these levels I think the share price is relatively fairly anchored, given the operating fundamentals.

Mark Ingham is an independent investment analyst, and this special podcast was brought to you by EasyEquities.