When there’s a mad dash out of a sector, you often find that bargains begin appearing in places where valuations of affiliated but ultimately unaffected businesses get unfairly punished by association. So it is in the case of Glencore (LSE: GLEN), a commodities trading firm and mining company that has fallen out of favour recently due to the plunge in the price of oil specifically and commodities more broadly.
To gain a proper understanding of how this company operates a little differently from traditional drillers and miners such as Rio Tinto (LSE: RIO) (NYSE: RIO.US), Royal Dutch Shell (LSE: RSDB) and BP (LSE: BP), it’s helpful to dig a bit deeper into the company’s previous interim earnings statement. At the end of H114, Glencore reported adjusted EBITDA of $6.5 billion, which was up 8.5% on the same year-ago period. Of that, it reported that a chunky $4.9 billion was comprised of operating cash flow.
Compare this to Rio Tinto’s results, where cash flows from operations were just $2.7 billion on the back of similar profit before tax of $6.09 billion. It’s clear that there is a fairly wide berth between what Rio Tinto is doing and what Glencore is up to. But what is the magic ingredient that accounts for nearly double the amount of operating cashflow in the case of Glencore?
Liquid Cash
Unlike major mining companies, Glencore makes sizeable earnings from marketing activities – today, sales and trading – related to a wide range of commodities.
Thus, while commodities prices didn’t fare the best over the first half of last year, strong volumes among copper and thermal coal trading meant that the firm was able to show some stellar earnings results on the back of, in large part, income derived from activities related to brokering these commodities.
Glecore’s comparatively high operating cashflow has meant the company was in the perfect position to enhance earnings in creative ways, which it did by announcing a buy-back of $1 billion of its own stock. That move may prove fortuitous, for it comes just as profitability is on the rise and the company’s share price has begun to look considerably cheaper (Glencore has fallen 17% over the last half-year period). This is a wonderful scenario as far as shareholders are concerned, since they can now expect to participate in earnings increases derived purely from the company’s dividend payouts, compounding upside.
Well Diversified
Glencore works a little differently to traditional mining companies in that it’s really a sort of hybrid broker-miner to the commodities market. (It is from this legacy from which the firm hails from, after all, as the Mark Rich commodities trading company). So in addition to benefiting from multi-directional markets where volumes are high, Glencore’s management team is always focused on making smart, low cost acquisitions of mining and commodities firms where synergies are high for Glencore to roll out its giant distribution model across the global commodities trading floor. Savvy acquisitions such as those of Xstrata in the past few years have thus meant that the company is still getting better value on mining activities than competitors despite a weak market price.
But that’s not all. The company is the most diversified natural resources company around. Compare that scenario to Shell, which is pure-play oil and gas, or Rio Tinto, which is essentially a one-way directional bet on metals prices and it quickly becomes clear how much hidden value lies beneath the surface than can be gleaned from Glencore’s day-to-day market environment.
Distinctions such as these are easy to forget in the midst of the deafening crushing of commodities prices, but they are critical: 42% of Glencore’s earnings come from marketing activities; of combined marketing and mining activities, 14% of earnings are from agricultural products and 16% are from energy products, with the remainder derived from metals.
In other words, it’s going to take much more to impact this broad, far-reaching giant negatively. Given the traditionally higher multiples commodities firms can command, the shares, at 17 x earnings, look like temporary bargain here.