Significantly higher commodity prices made for a strong first half at Xstrata, which turned in a 43% top-line expansion to $13.6 billion accompanied by EBITDA growth of 67% to $4.5 billion. Looking ahead, Xstrata noted that the current outlook remains "mixed," pointing to a "three-speed" global economy led by the emerging markets of China, Brazil, and India, followed by what appears to be a steady recovery in the U.S., and Europe bringing up the rear. Of course, as far as the near-term outlook for metals and coal prices are concerned, no market is more important than China. On this topic, management observed that the economy is "clearly slowing" but nonetheless expressed confidence that the Middle Kingdom is headed for a "soft landing."
Not surprisingly, Xstrata's balance sheet--a source of concern in the throes of the global financial crisis--exhibited marked improvement year-to-date. Net debt declined to $8.4 billion from $12.6 billion at year-end 2009, buoyed by free cash flow ($1.58 billion) and Glencore's exercise of its Prodeco call option ($2.25 billion plus the balance of Xstrata investments and accrued profits). Net debt/net debt plus equity dropped to 19%, below the 26% at year-end 2009, a level management had previously remarked was "in line with...long-term targets."
This of course, begs the question: if management views its balance sheet as underleveraged, what might it do with the dry powder? The company continues to be the subject of rampant speculation concerning its next big move on the M&A front, not surprising given the current management team's historically ample appetite for acquisitions. Despite nonstop market speculation ranging from a combination with commodities trader and 34% Xstrata owner Glencore (more on this below), the purchase of the 75% of platinum producer Lonmin that it doesn't already own, or even a renewed approach at reluctant partner Anglo American, Xstrata seems, for the moment, comfortable with tending its own garden--a marked contrast from the past several years. (Read Morningstar's full analysis of Xtrata here.)
Of course, lacking a well-placed mole or remote monitoring device in Xstrata's executive suite, we only have management's public comments, which suggest the company's strategic focus will remain on its substantial organic growth pipeline. On this topic, management reiterated expectations of $14 billion in expansionary capital expenditures from 2010 through 2012 (versus roughly $7 billion in the three years prior) and announced it had received approval for the massive Las Bambas project in Peru, a $4.2 billion greenfield mine expected to produce 880 million pounds per year once completed in 2014. This announcement follows other recent approvals in the copper space, including the July approval of a $1.5 billion expansion at Tintaya and January approval of $1.3 billion extension of Antamina. We had already incorporated Las Bambas' capital expenditures and associated output in our model, so the announcement of the project approval prompts no revision to our forecasts.
As we've noted before, many of Xstrata's larger projects like Las Bambas and the Koniambo Nickel project, once initiated, are relatively inflexible with respect to the timing and size of their capital requirements. Given this constraint, we don't anticipate growth by means of massive cash-funded acquisitions that defined most of Xstrata's history. But an all-equity deal certainly remains on the table should the terms look good. With this in mind, a combination with Glencore seems the most likely "transformative" deal. That said, we wouldn't expect to see much movement on this front until the privately held trading giant sees its shares listed on a public exchange. In the absence of a market-determined equity valuation, it would be very difficult to get holders of the 67% of Xstrata not owned by Glencore to sign on to such a combination.
