Glencore still hobbled by legal investigation

There’s no respite for the mining business today, but analysts think the shares are undervalued.

Misfiring Glencore (LSE:GLEN) shares served up more frustration for UK investors today, with better-than-expected annual results overshadowed by continued uncertainty on several fronts.

One of the biggest worries remains the US Department of Justice's ongoing investigation into Glencore's compliance with the Foreign Corrupt Practices Act, which has caused the commodities and trading giant's shares to underperform FTSE 100 index peers since 2018.

There have also been a series of challenges in the Democratic Republic of Congo, from where the company is at the forefront of production of cobalt used in batteries for electric vehicles.

A saturated market, however, caused an average 57% slide in cobalt prices last year and contributed to Glencore's decision to halt production at its Mutanda mine. This shutdown was one of a number of write-downs across coal, oil and copper assets behind a bottom-line loss of $404 million for 2019 — the company's first deficit in five years.

Weaker commodity prices were also responsible for a 26% drop in underlying earnings to $11.6 billion, with copper down 8%, zinc off 13% and thermal coal 27% lower on average. Glencore said this was despite supply/demand balances for most commodities being reasonably healthy, with copper, zinc and nickel markets particularly tightly balanced.

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The overall earnings figure was stronger than City forecasts, with both the marketing and industrial divisions showing signs of progress over the second half of the year as the cobalt market rebalanced and coal operations benefited from growth in Asian thermal demand.

At the start of 2020, however, the market backdrop has been clouded further by the potential impact of coronavirus. Shares fell 3% today despite Glencore pointing out today that its defensive qualities had been shown over many cycles, due in part to its marketing activities as well as material exposure to precious metals.

Source: TradingView Past performance is not a guide to future performance

Analysts at Jefferies reiterated their “buy” recommendation and price target of 285p in the wake of the results, based on expectations for strong growth in underlying earnings and free cash flow as markets for Glencore's key commodities tighten and prices rise.

They said: “Resolution of the ongoing DOJ investigation could be a catalyst for a more dramatic restructuring — i.e., spin off thermal coal — but timing of this is uncertain.

“While Glencore has its share of well-known idiosyncratic risks, it also offers investors leverage to commodities with attractive fundamentals and is trading at a depressed valuation.”

Glencore was the 12th most-bought stock among ii clients last year, but the fact that it was also the second most-sold suggests that some of this trading activity was speculative.

Analysts at UBS expect Glencore to trade at a discount until visibility improves on the DoJ investigation and there are further signs of progress in the Democratic Republic of Congo as the company drives a turnaround for its African copper operations. UBS has a price target of 270p.

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Even when factoring in the present impact of coronavirus on commodity prices, Glencore said its intention to distribute 20 cents a share for trading this year was comfortably covered 1.5 times by free cash flow.

Last year, it spent $4.7 billion on distributions and buybacks, including its $0.20 per share base dividend and $2 billion of share buy-backs. A further one-off award will depend on the net debt/adjusted earnings ratio moving closer to 1x, from 1.5x currently, and net debt reaching the $14-15 billion range from the higher-than-expected $17.6 billion at the end of 2019.