4 Reasons Holding Glencore Back (Rating Downgrade)

seekingalpha2024-10-27

Glencore's stock has gone nowhere in the past year, on account of the confluence of a number of factors.The company swung into a loss on impairments and even though an improvement is seen in H2 2024, ...

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The stock's high P/E and muted dividend yield doesn't help.There are silver linings like production in line with guidance along with the possibility of earnings' improvement in 2025, but they aren't enough.   Marlon Trottmann Since I last wrote about the Swiss multicommodity miner Glencore (OTCPK:GLNCY) (OTCPK:GLCNF) a little over a year ago, its price hasn't risen as I had anticipated at the time, which led to a Buy rating on it. A whole host of factors have gone wrong for the company, which explain investor diffidence on its price. It's not without its silver linings, though, as are discussed later here, but the underwhelming price movements merit a closer look at what's gone wrong, to determine what's next for it. Here are four factors working against it. #1. Loss on impairments  Glencore might have seen a turnaround in revenue growth in the first half of 2024 (H1 2024), with an increase of 9% year-on-year (YoY), in a sharp U-turn from the 15% drop in 2023, but the profits disappointed. The company reported a net loss (see table below) after it had already seen a 75% decrease in net profit in 2023. Much like for the full year 2023, impairments continued to be the drag on earnings in H1 2024. In the latest half year, the impairments as per the company pertained to \"lower thermal coal price assumptions and the ongoing export logistics challenges in South Africa\", along with the transition of the company's Koniambo Nickel operations into care and maintenance earlier in the year as they became unsustainable. Source: Glencore #2. Increased coal focus puts question mark on sustainability  In July, the company completed the acquisition of the Canadian coal miner Elk Valley Resources in an all cash deal of USD 6.9 billion, adding another 20% to Glencore's existing production of coal and would bump up the adjusted EBITDA by ~16%. The company had intended to spin off its coal business into a separate entity with the acquisition, but shareholders voted against that. This is problematic to the extent that it sets the company back instead of making gains in the transition towards decarbonisation, bringing its sustainability into some question considering the significant share of fossil fuels in its profits already. Even though the contribution to adjusted EBITDA from its energy and steelmaking coal division declined to 42.7% in H1 2024 from 62.3% in H1 2023 42.7% in H1 2024, it still remains substantial. And will soon look much bigger again after Elk Valley Resources' contribution is added to the segment. To be fair, there's a good explanation for why the segment's demerger did not go through. As per the company's statement, the segment can allow Glencore to generate funds, which in turn can be used to expand the company's interests in transition metals, like copper. This can happen, considering Glencore has substantial copper production already, and with 18% year-to-date increase in the red metal's price, it stands to make gains from focusing on it too. But how fast it can expand its focus remains to be seen. #3. Market multiples are high, even if positive earnings come through With the weakness in earnings, Glencore’s forward price-to-earnings (P/E) ratios look elevated now. As per analysts' estimates on Seeking Alpha, its forward non-GAAP P/E is at 15.7x, which indicates a 59% overvaluation from the ADR's five-year average of 9.9x. It's also higher than the 11.8x a year ago, when I last checked. The forward GAAP P/E is even higher at 27.3x compared to 11.13x in September 2023. While it's some comfort that the non-GAAP forward P/E is still slightly lower than the average for the materials sector, it's not materially so. And the forward GAAP P/E is actually much higher (see table below). I'd take these numbers with a pinch of salt though, considering the latest losses. Though on the flip side, the stock can rise if its earnings do improve in H2 2024. #4. Slashed dividends, muted yields  Last year, I had said that investors \"should brace for a dividend cut\" based on the company's sagging earnings. My estimates indicated a decline of 28% for this year, assuming that the payout ratio remains constant at the 2022 level of 39%. In actual fact, the dividend cut was far more dramatic, by a whole 70%. As a result, the stock now has a trailing twelve months [TTM] as well as forward dividend yield of just 2.5%. By comparison, its five-year average TTM yield is 4.5% and forward yield is 4.8%. With the company's earnings expected to decline by another 38% in 2024, another cut could be coming in 2025. If it's some solace though, the figures remain higher than the median for the materials sector (see table below).   Source: Seeking Alpha The silver linings The company and the stock aren't entirely devoid of redeeming qualities, though. Here are two of them:  Production on track: Even as the company's production in H1 2024 is reduced from last year (see table below), it's still broadly in line with the production guidance for the year. In fact, production for commodities like copper, zinc and ferrochrome can either stay in line with that in 2023 or exceed it this year. It's steelmaking coal, of course, could even see an almost 3x increase due to its Elk Valley Resources acquisition. Source: Glencore  Earnings can improve in 2025: Further, its prospects for next year look better, at least right now, with analyst expecting a 43% increase in EPS (see graphic below). This is possible, considering that impairments on account of logistical and ceasing operations have been a drag on the company's earnings this year. Further, there could be possible improvements in global economic demand, including the hopes of a fiscal stimulus from China next year. However, the fact remains that energy products are a significant contributor to earnings. And coal in particular, is expected to continue seeing weak prices. Source: Seeking Alpha What next? While the silver linings are encouraging, the challenges for the stock right now, are overwhelming. Losses on impairments, increased focus on fossil fuels, high valuations, in the event that Glencore winds up with a profit for the full year 2024 and muted dividends all work against it. If its earnings figures turn positive in H2 2024, the stock can stand to make gains. But we don't know that yet. In any case, analysts expect earnings to shrink considerably YoY. Next year is expected to be better, but it's best to wait and watch for now. There's no real impetus to buy Glencore right now. I'm going with a Hold rating.  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. 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