Glencore, an overvalued Japanese throughput manager

Posted by Izabella Kaminska on Jun 16 11:20. Comment | Share

“World’s biggest IPO”. “Unquantifably unique”. “No natural like-for-like”. “A trading house like no other”.Whatever.

Analysts at MF Global are not buying the PR spin.

Glencore might be the emperor of the commodity world, More…

“World’s biggest IPO”. “Unquantifably unique”. “No natural like-for-like”. “A trading house like no other”.

Whatever.

Analysts at MF Global are not buying the PR spin.

Glencore might be the emperor of the commodity world, but to them he’s probably got no clothes on.

Cue one controversially low target price of 390 pence per share (versus  a 530 per pence IPO price and a pixel time quote of about 461 pence) and some hard hitting observations.

They’re unimpressed because,  having looked at the numbers, they didn’t see any reason at all to differentiate the company as the “one and only” it’s been heralded to be.

Indeed, MF Global sees its model as very similar to any of the key Japanese traders — Sumitomo, Mitsubishi, Mitsui and such the like.

A fact which should, by any means,  bring about some of the following reality-checks:

We think that every company has its unique features, but a glance at the Japan traders and Glencore’s P&L notes what they have in common: large affiliate profits and a profit profile that mirrors commodities prices. We think that, as a new listing, what may be helpful to investors is a financial review. The Japan traders provide a financial framework and, in our view, the IPO prospectus’ structures need not be taken as necessarily the right ones.
——
We are struck by the higher valuation of Glencore against not just the Japanese traders but also the international miners and securities brokers.
We imagine that the IPO price was set with the idea that Glencore had no comparable competitor..

For those who still think Glencore’s trading profile is somehow unique, MF says:

Both Glencore and the Japan traders make money in Metals, Mining, Energy and Food. They both have upstream as well as trading activity; but the traders’ upstream assets are of far higher quality. Glencore is not more complex than the traders and not more difficult to value.

The routine filling of long term contracts is behind the trade processing of all of these kinds of companies. We don’t find evidence that Glencore’s principal trading produces better margins than the Japanese traders’, nor evidence that it has sounder finance, or better assets.
————–

It is expensive whether considered as a brokerage, a miner, or a trading house. The Japanese trading companies come out well from any comparison.

As to the similarities:

Affiliates, listed stocks, and a mixture of mining and trading add complexity to both Glencore’s and the traders’ accounts: but this is, in fact, precisely what they have in common. We think that their business profits–raw materials procurement and marketing–are substantially the same.

Despite the complexity the market has little trouble in pricing the Japanese traders, at PEs of about 6x and PBRs of 0.9x. The historic measures are of course a touch higher. (Please see Appendix 29.) The forward 0.9x PBRs are not much different from those of the major investment banks, while the PEs are not so different from those of the international mining groups. (please see Table 7A.) We note some summary details of their and Glencore’s historic financials as Appendix 5.

As may be seen Glencore strongly resembles the traders’ size and shape, financially. Like them it buys goods from miners3 and has mining assets. Some parts of final volume are from controlled sources, some have to be sourced in the market. Concomitant with trading of this kind is an ability in logistics management and an ability to handle the mechanics of delivery.

And should they really be viewed as traders at all? MF considers them more throughput manager than hard-nosed trader:

As 98% of inventory is already sold/hedged it rather looks as if Glencore is a throughput manager rather than “trader”. That makes it look very much like the throughput operation of the Japanese traders. We note the use of the word “marketing” throughout the prospectus in place of “trading”.

4) The company claims some large market shares in its “addressable markets”; namely 63% of Zn, 50% of Cu, 43% of Pb, and 21% of Al. If the company really is 50% of its market then it’s not easy to see how it could liquidate all at its “hedged” prices.

5) Either the goods are sold, or not.

And let’s face it, with all its exceptionals, the accounting isn’t helpful either:

Trading is an asset business. Equity markets can—if they choose an earnings based valuation—capitalize the perceived earnings stream. This entails understanding the components of the income statement. There is no compulsion in a market to capitalize a stream that it can but dimly perceive.

The company gives, in addition to the main P&L, many details of exceptionals and calculations that are unusual. We give the whole P&L as Appendix 6. We suspect that investors need to master the intricacies of the old equity attribution so as to assess management’s understanding of value and its attitude to profits.

In the past, given the existence of bonded debt, there was clearly a need to manage the D/E ratio: and one way16 to do that was to reward staff bonuses in stock. Given that the dividends were very small, we can but think that trading staff would have preferred cash. Sometimes the attribution to PPS holders was about their 70% of the company’s group NP, sometimes more, sometimes less17. If rewards had been more cash based, then the company’s declared NP would have been smaller and the D/E ratio, higher.

———–

The lack of proper inter-segmental breakdowns assists neither with understanding the breakdown of gross and operating profits between the marketing and production arms, nor the expectations of marketing staff from their shareholdings. Goodwill is subsumed in the figures for investments.

Which brings MF to the risks:

GLENCORE faces the usual risks of any broker/trader: liquidity and value of inventory and the clemency of its banks. In particular it faces the risks of falling commodity prices and losses from committed delivery services. In the oil business the company operates more than 150 tankers on time charters and has oil in 55 tank farms.

To sum up: Glencore, not so special at all.

More of the slaying over here.

Related links:
The UK flotation jinx – FT Alphaville
Xstrata extrapolated (thanks Glencore)
– FT Alphaville
The Glencore market-timing myth
– FT Alphaville

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