Shares in Glencore (LSE: GLEN) edged lower on Tuesday morning, after the firm’s first-quarter production update showed falls in own-sourced copper, zinc and nickel output, compared to the fourth quarter of 2014.
Glencore’s oil production rose by 52% to 2.6m barrels, but this too was lower than expected, according to some forecasts.
Against this backdrop of lacklustre performance, Glencore’s 2015 forecast P/E of 16.8 times 2015 earnings seems ambitious to me, even allowing for the expected strong earnings growth in 2016, which is forecast to push Glencore’s P/E down to 12.5.
Why I’m worried
Despite its large-scale mining operations, the majority of Glencore’s turnover comes from its trading operations, in which it acts as a middleman, buying and selling vast quantities of other raw commodities such as coal and oil, which are produced by other firms.
In 2014, 41% of Glencore’s adjusted operating profit came from trading — but this accounted for 81% of its $221bn turnover.
Glencore’s operating margin from trading was just 1.6% on turnover of $178bn while its mining operations generated an operating margin of 9.2% on turnover of $42.6bn.
Although there’s no doubt that Glencore is one of the world’s top commodity traders, I’m not sure I see the attraction of this low-margin business as a potential shareholder.
Glencore’s profits have fluctuated wildly since its floatation in 2009, and while net debt has risen by an average of 15% per year, the firm’s dividend has only climbed by around 5% per year.
Glencore shares have risen by 10% over the last month, but remain 42% lower than when the firm joined the stock market in 2011 — in my view, it could be time for commodity investors to look elsewhere.
A better alternative?
Over the same four-year period, shares in Royal Dutch Shell (LSE: RDSB) (NYSE: RDS-B.US) have fallen by around 1.5%. The shares are currently down by 5% this year, but I believe now could be a good time to buy, as I expect the outlook for oil majors to improve over the next 12 months.
Here’s why.
Firstly, it’s worth remembering that heavyweight oil majors like Shell will have huge negotiating power when it comes to cutting costs.
As we’ve seen with UK supermarkets, firms like Shell will make sure that their suppliers feel a lot of the pain caused by falling oil prices.
Secondly, at more than $65 per barrel, Brent crude is now trading around $20 per barrel higher than it was when the market hit a low in January.
I believe that the worst of the oil price crash has now passed, and oil prices could even edge a little higher during the second half of the year.
Finally, over the longer term, I believe Shell’s offer to purchase BG Group will prove to be a wise move.
The quality and scale of BG’s assets are not in question, and Shell has now secured a raft of new reserves much more quickly and cheaply than would have been likely via exploration.
Buy Shell?
Trading on 10.8 times 2016 earnings and with a prospective yield of 6.0%, I believe Shell shares are a clear buy.