Equity analysts are upgrading their fair value estimate on no-moat rated Glencore (GLEN) to 250p from 240p previously. The primary driver is depreciation of the GBP/USD exchange rate from 1.32 to 1.27.
We also incorporate updated guidance for production and costs across its mining business and softer short-term guidance for marketing. On a net basis, those changes are a wash.
On the plus side, volume guidance for cobalt, zinc, coal, and ferrochrome is stronger and the outlook for copper cash costs is better than expected. Headwinds are from copper volumes, lower near-term marketing margins, and rising cash costs for nickel and zinc. Capital expenditure also increased.
The last few years were kind for Glencore with benign cost pressures, low capital expenditure and generally rising commodity prices. This has allowed Glencore to repay significant debt. The firm is loath to increase debt to boost shareholder returns and wants to retain some headroom within the self-imposed debt limits to make countercyclical acquisitions or investments.
Dividends and Buybacks Boost
Glencore reaffirmed its commitment to shareholder returns, with managing director Ivan Glasenberg suggesting scope for regular dividends of about $1 billion per quarter. It’s likely any additional free cash flow in excess of the dividend will be directed to share repurchases. We now forecast $2 billion of on-market buybacks for both 2018 and 2019, equating to about 7% of issued capital.
With the shares trading about 14% above our fair value estimate, the repurchases are mildly dilutive. Overvaluation reflects coking and thermal coal prices that are well above our long-term assumptions.
Glencore says market sentiment has taken a hit due to concerns around trade, China, and the broader economy. However, it says underlying demand remains strong and capital expenditure remains relatively subdued, which bodes well for future prices.
China’s Economic Strength a Threat
Despite Glencore’s bullish comments, our view remains that China has risen faster than previous developing economies and that more of the country’s commodity consumption runway is used up. Steel is the prime example with China’s annual consumption at Western world levels. If it continues to consume steel at these rates, the total steel stock in China’s economy – the sum of all steel in cars, buildings, etc. across time – will reach developed economy levels in a decade.
For this reason and given the reliance of demand on bloated capital expenditure, we think overall steel consumption in China is likely to decline. In addition, a greater proportion of future steel supply is likely to come from scrap as steel in cars, machinery, and buildings from the early part of the China boom start to reach the end of their useful lives.
Overall, Glencore expects to grow volumes meaningfully in the three years to 2021.
From 2018 levels, the firm expects to lift copper output by 5%, coal and nickel by 10%, zinc and lead by about 30%, and cobalt by 74%. However, cash costs for zinc and nickel in particular are set to increase in 2019 due to contributions from higher cost sources.
