GLENCORE is the ultimate inflation Hedge

The global recovery from the COVID-19 – much faster and stronger than expected

In spring 2020, amid global lockdowns due to the pandemic, the world was litterallly awashed in commodities such as oil, coal, natural gas. The world economy and our societies were litterally brought to a standstill at that time.

But since then, things have gradually improved and prices of metals, including copper, cobalt and nickel and energy commodities such as oil, natural gas and coal have surged as demand rebounded from the Covid-19-induced slowdown.

Following COVID-19’s severe global impacts in early 2020, energy supermajors such as ExxonMobil, Chevron, Royal Dutch Shell have deepened their cuts into capital spendings and streamlined their operations.

Mining companies such as Anglo American, BHP Group or Rio Tinto have cut their investments as well with the consequence that high global demand is met with muted global raw material production capabilities. So, the global economic recovery has seen prices of most of commodities steadily surging to multi-year highs amid accelerating and demand on one side and lingering supply constraints on the other side.

Which asset classes tend to do well amid rising energy prices?

As the IEA key world energy statistics 2020 shows, oil continues to hold the largest share in the energy mix, accounting for almost one third. Coal is the second largest fuel and accounts for more than one quarter of the total world energy consumption, followed by natural gas, slightly below 25 %. Renewables such as wind energy etc. have grown considerably in the last years and now make up almost 6 % of the total energy mix.

Global demand for coal is even expected to rise by almost 5 % in 2021 after the severe pandemic-led drop in 2020. That rebound is in essence due to an increase in coal-fired power generation in Asia. Several countries including China are building new capacities and in 2021, the price of coal has outperformed other commodities including oil, copper and iron ore.

So, with multi-year record prices for almost three third of the top energy commodities (oil, coal and natural gas) it is clear that global production costs will rise, which will eventually passed on to consumers with higher prices for goods and services.

Companies with strong brand portfolios and dominant market positions tend to have some pricing power and at least have the possibility to safeguard their earnings power amid rising production costs. Consumer staple giants such as The Coca Cola Company, PepsiCo, Hershey for instance. Or luxury goods company Louis Vuitton Moet Hennessey or cosmetic giant L’Oreal. But of course, even these giants won’t be immune against higher production costs.

Inflationary tendencies are going to have also an influence on interest rates, and it will be interesting to see the actual impact on the Gold price and real estate markets as well on Cryptos (see here also a comparison of Bitcoin and Gold).

Mining giant such as Rio Tinto and BHP group have cut their exposure to coal significantly in the past. BHP has sold of its oil and natural gas reserves to British Petroleum (BP). So commodity businesses like Rio Tinto and BHP group are no beneficiaries of rising prices for oil, coal and natural gas and their production costs are even negatively affected.

BP, ExxonMobil, Chevron and Royal Dutch shell will see higher cash flow generation. But these companies have slashed their capital investments significantly in the previous years. My guess is that they will steadily ramp up investments over time – at significantly higher costs. These oil and gas giants tend also to prioritize shareholder remunerations over investing in growth (see also here the article on Royal Dutch Shell and its capital allocation programme).

One company that has significant exposure to the energy market and that has been investing heavily into its future production capabilities is GLENCORE.

GLENCORE is in a sweet spot amid an inflationary environment

Company Snap-Shot

GLENCORE – in contrast to Anglo American, Rio Tinto or BHP Group – is not only a mining firm but also a commodity trader which gives the company a more diversified edge.

The company which sports a market cap of roughly USD 70 Billion provides services (like storage, financial and logistical) to commodity producers. It is also a large producer of commodities itself through owned assets across metals ranging from thermal coal, coking coal and copper to zinc, nickel, and ferroalloys.

The Anglo-Swiss multinational commodity trading and mining company GLENCORE was founded 1974 and is headquartered in Baar, Switzerland.

Positioned for Growth

Revenues and free cash flow attributable to coal got a strong boost for GLENCORE. Copper, zinc, and nickel are all still quite strong but coal price has been surging most dramatically.

Now, GLENCORE’s acquisitions of coal assets in the last years are really paying off.

For instance, in 2020, GLENCORE became the sole owner of the Cerrejon thermal coal mine in Colombia by buying out its partners BHP Group and Anglo American. GLENCORE was boosting its coal assets at a time when others are looking to exit the sector and was the beneficiary of attractive acquisition prices.

GLENCORE also too 100 % ownership of the Rolleston thermal coal mine in Australia’s Queensland, after agreeing to buy Japanese firm Sumitomo’s 12.5 % stake and having completed the purchase of a 12.5 %c stake previously held by Itochu last year.

GLENCORE’s move to full ownership was part of a wider trend for global conglomerates, particularly Japanese firms, selling out of minority holdings in thermal coal mines under pressure from those concerned about climate change.

A deleverage play

What’s interesting is that after 2020, which was a tough year for commodity businesses like GLENCORE, that company not only managed

to heavily invest into future growth but also

reduced debts significantly.

GLENCORE had stopped dividend payments in 2020 to preserve cash and in combination with higher commodity prices worked hard on cutting debt to USD10.6 billion from USD15.8 Bn at the end of 2020 which is within its target range of USD 10 BN- USD 16 Bn which GLENCORE said it would need to reach before increasing dividends.

A cash rich bonanza for income investors

After having slashed its debt level by one third to its target in a matter of just a few months, GLENCORE reinstated its dividend in February 2021. Morevoer, the company is returning cash not only through regular dividends but also through special dividends, and buybacks in the amount of USD 650 million in the third quarter of 2021. Share buybacks will reduce the stock count and positively contribute to earnings per share growth.

Amid multi-year high prices for coal which is one of the main products of GLENCORE, free cash flow streams will grow even significantly stronger and given ample reserves already acquired in the past years, the company is perfectly positioned to return “surplus capital” to shareholders in the short and medium run.

Risks to consider

Now, as it is always when it comes to acquiring a stake in a business, there are always risks involved. GLENCORE as a commodity company in the past had human rights and environmental issues. These are not just reputational risks, but can also severely impact the earning power of the company.

And of course, GLENCORE is a “price-taker”, most of its profit come from commodities whose value fluctuate over time.

Final Thoughts on GLENCORE as investment case

Glencore looks quite attractive currently. It has successfully deleveraged over the last 12 months, invested into future growth and is positioned in commodities that are marking multi-year high prices. GLENCORE is set to reward shareholder handsomely and what’s even best, that these distributions and buybacks won’t come to the expense of capital expenditures which build the basis for future growth.  

You are responsible for your own investment and financial decisions. This article is not, and should not be regarded as investment advice or as a recommendation regarding any particular security or course of action.

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