Monday, May 23, 2011

Commodity Trader Glencore (805.hk) IPO Stock Analysis

If you are considering to invest in Glencore, a leading Switzerland-based physically moving commodity trader, we hope you to read through this article before doing so. At least it can save your time in reading the lengthy IPO (Initial Public Offering) prospectus.

Honestly speaking, before we published our first Stock Analysis about Hui Xian REIT (87001.hk), we did not imagine that it could achieve such a great success (it is now one of our top 5 most popular articles by mid May). That is why we decide to publish more stock analysis for our readers in this website.

The Swiss-based Glencore International Plc, headquartered in Baar, is one of the world's largest integrated traders, producers and marketers of commodities such as metals and minerals including aluminum, alumina, ferroalloys, nickel, cobalt, iron ore, lead, copper and zinc, energy products including crude oil, gas, coke and steam coal, as well as agricultural products including wheat, rice, grains, corn, barley, biodesel, cotton, sugar, edible oils and oilseeds. Glencore provides worldwide marketing, refining, financing, sourcing, processing, production, third party supply, distributing, logistics and other supply chain services, such as transportation and storage, to producers and consumers of commodities. The secretive Glencore also owns a number of publicly listed assets including 34.5% of Xstrata Plc (XTA) from the U.K./Switzerland, 74.4% of Katanga Mining (KAT) from Democratic Republic of Congo (DRC), 8.75% of the biggest aluminum producer United Co. Rusal from Russia, 82.3% of Murrin Murrin nickel miner from Australia, 44% of Century Aluminum from the U.S., 4.1% of Volcan from Peru, 51.5% of Chemoil Energy from Singapore, 7.8% of Nyrstar from Belgium, 32.2% of Recylex from France, 60.3% of Biopetrol Industries AG from Switzerland, 6.3% of Polymet Mining from Canada etc and many other privately held companies. Their customers cover a wide range of industries including oil, power generation, automotive, steel production and food processing.

Prior to the IPO listing, Glencore is privately owned by its senior management and employees. In this IPO, Glencore targets to raise a total of USD$10 billion, by issuing up to 1.169 billion of ordinary shares (246 million of them are existing shares to be sold for taxation purposes, assume no over-allotment option is exercised and no Kazzinc Consideration Shares are issued), 97.33% of them will be listed in London, the rest 2.67% will be listed in Hong Kong.

Glencore will likely be the largest-ever IPO in London if over-allotment option is exercised, and will be immediately included in the FTSE-100 Index as bluechip under the fast entry rule on 24 May 2011, the first unconditional trading day for its primary listing (LSE: GLEN.L) on the London Stock Exchange. A day later, on 25 May 2011, shares will start trading unconditionally for its secondary listing (stock code: 805.hk) on the Hong Kong Stock Exchange (HKEx stock code: 388.hk). Glencore's top IPO cornerstone investors are Abu Dhabi state-owned IPIC (International Petroleum Investment Company) Aabar from United Arab Emirates, BlackRock Fund (BLK) from the U.S., Bain Capital from the U.S., Credit Suisse AG from Switzerland, Fidelity Investment Fund from the U.K., UBS AG (UBSN) from Switzerland, Zijin Mining Group (2899.hk) from China and also sovereign-wealth fund Government of Singapore Investment Corporation (GIC). After the IPO, cornerstone investors will be subject to a lock-up period of 6-month for their shares, and Glencore's existing shareholders (including Glencore's executive directors) will also be subject to a lock-up period gradually from 1 year to 5 years for their shares.

Here are the details of our Glencore's stock analysis:

Profit (HKD trillion)Number of Dilutive Ordinary Shares in issue (trillion)Earnings per Dilutive Ordinary Share (HKD)Price/Earnings (P/E) Multiple
Notes(1)(2)(3)(4)
2010107.591.3250.29
201122.687.592.9922.25

(Source of IPO Prospectus: Hong Kong Stock Exchange - HKEx stock code: 388.hk)


USD/HKD = 7.7751

Notes:

(1) In 2010, Glencore's income mainly attributed to its employees who owned profit participation certificates. These profit participation cert-holders were paid USD$2460 million, even more than a double of Glencore's net profit (USD$1290 million) in the year. Profit participation certificates will be exchanged for ordinary shares after Glencore's restructuring for IPO.

We are disappointed to know that Glencore has applied for, and HKEx has granted, a waiver to allow Glencore not to include any 2011 profit forecast in its IPO prospectus. Our Glencore's 2011 profit prediction then becomes difficult and we can only do it by our own estimation on commodity market trend. Nevertheless, Glencore's marketing operations are less correlated to commodity prices than its industrial operations. Hence Glencore's earnings can probably be a bit less volatile than other pure commodity producers which do not also have marketing and logistics operations.

Remark: Glencore has also been granted from HKEx more waivers to allow Glencore not to disclose the interests of Directors and their associates even they hold more than 5% shares of Glencore's largest customers, not to disclose the handling details of Glencore's treasury shares, not to fully obey the Code on Corporate Governance Practices in Hong Kong etc, just for the reason that they already comply with U.K. Listing Rules or Jersey Companies Law, and it could be unduly burdensome for Glencore to be subject to extra disclosures and corporate governance requirements set by Hong Kong Listing Rules.

(2) The Stabilizing Manager, Morgan Stanley, has been granted an over-allotment option, also known as the greenshoe, to issue up to an additional 10% of IPO shares during the stock price stabilization period. Number of dilutive ordinary shares in issue can then be up to 7.59 trillion in 2011, assuming the over-allotment option is fully exercised, Kazzinc Consideration Shares are all issued, and all the owners of Glencore Finance (Europe)'s convertible bonds exercise their right to swap their bonds for shares.

We also assume Glencore had the same number of 7.59 trillion ordinary shares in issue in 2010, just for comparison purpose.

Glencore has been granted a waiver from HKEx so that it will be able to further issue shares held in treasury before the end of 6-month restriction period after IPO listing in Hong Kong. Please be aware that further share issues or conversion of the convertible bonds will dilute the interests of shareholders.

(3) We calculated Glencore's earnings as HKD$2.99 per dilutive ordinary share in 2011, however, this valuation is not risk-free. Glencore is generally exposed to geopolitical risk which may result in expropriation of assets, liquidity risk under interest rate hikes and tighter credit markets, counterparty risk in highly volatile commodity markets, corruption risk as Glencore's industrial operations are located in countries where corruption is understood to exist, and also to risks related to declines in the volumes of supply or demand for commodities, reduction of credit rating as well as crash in commodity prices which may induce decline in the value of inventories and write-downs. Glencore is now rated BBB- (stable) and Baa2 (negative) by Standard & Poor's (S&P) and Moody's respectively.

Since it is based in Switzerland, Glencore can do a lot more than Goldman Sachs or Morgan Stanley after the Dodd-Frank financial-regulation law (including the so-called Volcker rule) enacted last year. Glencore, as it also owns and operates refineries and mines, could gain an exemption from the Dodd-Frank Act. Glencore's average 2010 value-at-risk (VaR), which estimates based on a statistical 95% confident level how much its traders could lose in a single day, jumped to USD$42.5 million from USD$26.4 million in 2009, surpassed Goldman Sachs's commodity price value-at-risk (VaR) that dropped to USD$33 million in 2010 from USD$36 million in 2009.

After 37 years as a private company that faces no limits on leverage, compensation or proprietary trading, upon the IPO, Glencore will be pushed into public eyes and may then have to engage in its business more transparently.

(4) Stock price to be set as HKD$66.53 (530 pence) per ordinary share, which is near the amended minimum offer price of its IPO. Our Glencore's 2011 forward Price/Earnings (P/E) multiple is calculated as 22.25 times, indicating that we are not as optimistic as Glencore's IPO managers or bookrunners who estimated a 2011 P/E of 8 to 10 times for Glencore. Our calculated P/E of 22.25 times is also much higher as compared to 14 times P/E ratio of Noble Group in the same industry, a small Glencore's competitor which is now publicly listed in Singapore.

Bear in mind that a relatively high P/E, though looks expensive, can still be justified if people believe it is the best-in-class company and are willing to pay the premium.

Glencore intends to pursue a progressive dividend policy. However, distributions can be subject to Swiss Withholding Tax (currently at 35%), and Glencore may only pay out 65% of the gross amount of any dividend and similar distributions to shareholders. Please consult your own professional tax adviser if you are in doubt about your tax position.

Usage of the IPO funds:
(i) to pay USD$2.2 billion to Verny for Glencore's proposed acquisition of additional stakes in Kazzinc, a Kazakhstan-based metals producer, from 50.7% to 93%.
(ii) to fund USD$5 billion for its expansion projects in respect of Kazzinc, Prodeco, Mopani and West African Oil Assets.
(iii) remaining balance will be used to reduce borrowing costs by repaying debt obligations.

After the IPO, Glencore may also seek to merge with Xstrata Plc (XTA), the world's 4th largest diversified mining group by revenue. Given the current boom in commodity prices, it is probable that Glencore will overpay for the acquisitions and expansions.

Our stock analysis conclusion is: Having considered all the factors mentioned above, we do not recommend a buy for this Glencore IPO. We expect Glencore's stock price will be volatile, as the nature of commodities trading is not predictable. The biggest impact for Glencore should be the swings in commodity prices of copper or coal. Its stock performance may also be affected by the recent geopolitical turmoils in the Middle East and North Africa regions, as well as Japan's massive earthquake and nuclear crisis.

Last but not least, don't forget there had real example that stock price of closely-held partnership company like Goldman Sachs could crash in the initial year after going public.


Remark: There is no public offer in the U.S. for Glencore. U.S. persons will only be able to participate in this commodity trader Glencore's IPO if they are both (i) Qualified Purchasers (QPs) as defined in U.S. Investment Company Act, and (ii) Qualified Institutional Buyers (QIBs) as defined in Rule 144A under U.S. Securities Act.


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2 Comments:

CF Man said...

Your stock analysis looks a bit too professional. By the way, do you think it is a good time to buy Glencore now?

Mr China said...

Thanks for your comment.

As predicted, Glencore has not performed well since even its IPO debut last year.

Remark: Recap its Hong Kong trading debut on 25 May 2011, Glencore slipped by 2.5% to HKD$64.85 (Day High: HKD$65.7; Day Low: HKD$64.55) from IPO price HKD$66.53 (equivalent to 530 pence).

After IPO for almost a year, Glencore is still traded below its IPO price by now. Due to the selling pressure from its IPO price and the recent commodity market situation, at this moment we still do not recommend a buy for this stock.

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