There’s nothing worse than analysts labelling a company “dead money,” the slang term given to an investment that is unlikely to produce a positive return for the foreseeable future.
If the investment truly is dead money, the likelihood of a turnaround is low, and investors should consider selling the shares before incurring additional losses.
Unfortunately, the market seems to think that Glencore (LSE: GLEN) and Vedanta Resources (LSE: VED) are both dead money. These highly leveraged, operationally geared miners that lack pricing power, have been battered by turmoil in the commodity markets this year.
Indeed, over the past 12 months, Vedanta’s shares have collapsed in value by 36% and Glencore’s shares have declined 66%.
Recovery will take time
Until commodity prices stage a recovery, it’s unlikely that either Vedanta or Glencore will be able to return to their former glory. Still, concerns that Glencore and Vedanta are dead money could be overdone. The two miners remain profitable, just, and while there are concerns about leverage, the management teams have acted quickly to reassure the market.
Also, Glencore is doing what it can to improve conditions in the commodity markets. The company has decided to slash its zinc output by 500,000 tons per annum, which is expected to throw the global zinc market from a surplus to a deficit. The global zinc market faces a deficit of about 300,000 tons after the Glencore supply cuts, and the price of zinc has since rallied 10% since the announcement.
Moreover, at the beginning of October Glencore announced that it was mothballing some copper mines for 18 months, in an attempt to stabilise copper prices.
However, other miners don’t seem to want to cooperate with Glencore. Vedanta has sought to capitalise on Glencore’s decision to cut zinc output by announcing a $1.3bn expansion plan to ramp up zinc supply by 150,000 tons per annum. Meanwhile, Rio Tinto and China are both maintaining copper production with no plans to cut. China’s copper output actually increased by 2.3% during September.
As miners aggressively fight for market share, it looks as if the industry will take years to return to its former glory. Only the industry’s biggest players such as BHP Billiton (LSE: BLT) can afford to remain in business for a prolonged period. Although, with commodity prices where they are today, even BHP is struggling.
Debt binge
According to City figures, this year BHP will spend $2.5bn more than it can afford on its dividend and capital spending. Despite the company’s aggressive cost-cutting programme and low production costs.
To fund this deficit, BHP has turned to the debt markets, raising $6.5bn in debt during the past week. The new debt will add $160m per annum to BHP’s interest bill, an additional cost the company could do without.
And with the company struggling to pay its bills without borrowing there’s now an enormous question mark hanging over BHP’s 7.2% dividend yield. It is becoming apparent that the company is struggling in the current environment, the big question is, how much longer BHP can continue on its current path?
Sooner or later something will have to give.
The bottom line
Overall, I wouldn’t say that Glencore, Vedanta, and BHP are dead money just yet, but it could be wise to stay away for the time being.