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Glencore shareholders must have had different expectations of the future when the merger of Glencore and Xstrata was announced in 2013. By merging the core competencies in trading (Glencore) and mining (Xstrata), the newly created company planned to “capture value at every stage of the supply chain”. With a market capitalization of $65 billion, the company was geared towards strong growth in the commodity sector through easier accessible financing. However, this now seems to be the downfall of the Group.
The company today suffers from a high level of debt which amounts to approximately $29.5 billion. Although the rating agency Standard & Poor's recently confirmed the current credit rating of BBB, it changed the rating outlook to “negative”. The reason given was a further expected weakness and high volatility of commodity markets. If Glencore would lose its “Investment Grade" credit rating, it would negatively impact the short-term financing costs. The 1-year yield rose in the past few days from about 1.5 % in August to now well above 5%. The same development can be seen on the CDS market where the premium for a one-year maturity rose from 75bp to 1092bp (CDSs are trading instruments that can be used to hedge the credit risk of an issuer). In an attempt to avoid a downgrade Glencore already took action. It announced three measures: the cancellation of future dividend payments until further notice (dividend payments in 2014 amounted to about $2.4 billion); a capital increase by selling new shares in the amount of $2.5 billion; the partial sale of its agricultural business division. The goal is to reduce the debt burden by the end of 2016 to around $20 billion. However, whether these measures will suffice seems questionable. With a "Total Debt to Total Equity Ratio" of more than 104%, Glencore lags far behind its main competitors BHP Billiton (44 %) and Rio Tinto (50 %).
Glencore faces a long and arduous consolidation phase. Reducing the debt level and avoiding a downgrade of their credit rating must have highest priority. The slowdown of economic growth in Asia and especially in China weigh particularly hard as Glencore generates 40 % of its revenues in Asia.
The large number of short sales that we have seen recently is cause for concern and further negative numbers from Asia will further impact the share price of Glencore. While the reaction in the stock market seems exaggerated we expect a persistent high level of volatility. However, for risk-seeking investors with a longer-term investment horizon the current rates could signify entry levels.
Shareholders must have had different expectations of the future - the stock traded down to 66.67 GBp - 87 % below the issue price of 530 GBp.