Glencore PLC grew huge and prosperous behind a thick wall of secrecy. But its lack of visibility has now turned into a curse for the Swiss giant.
The sprawling enterprise, which controls much of the world's copper and zinc trading as well as a big slice of Canada's grain handling business, has lost more than half its market value since June. After its stock slid nearly 30 per cent in a single day, and worries about a possible default spiked to new highs, the normally publicity-shy company rushed to reassure anxious investors this week by issuing a detailed breakdown of its financing arrangements and shuttering a third of its zinc output.
Yet the storm surrounding Glencore shows few signs of abating. One basic issue is transparency – or the lack thereof. Until its recent troubles, the business was often referred to as the biggest company no one had ever heard of.
Worse yet, its roots are in commodity trading, a business that next to no one understands. Much of the anxiety around the company has focused on the "black box" of its trading operations, with some suggesting that the firm may be suffering from a big bet gone awry.
Experts say that's highly unlikely, but the fears persist.
"One of the key lessons to emerge from the last week of incredible volatility in the Glencore share price is just how little understood the trading business really is," says Paul Gait, an analyst at Sanford C. Bernstein & Co. in London.
For years, the dominant narrative painted Glencore as a giant octopus that stretched across global markets, collecting an unrivalled depth of information and using it to extract enormous profits. Story after story about the company included breathless depictions of its gargantuan size, descriptions of its secretive culture and odes to its market acumen.
Today, the Glencore mythology looks more than a bit naive. The company's core problem, according to observers, isn't its trading operations, but its diversification strategy. It blundered into making a huge wager on mining at exactly the wrong time and now finds itself struggling to deal with declining commodity prices and a heavy debt load.
The company's major misstep was its 2013 takeover of Xstrata, the huge miner that had previously bought Canada's Falconbridge. The deal, masterminded by Glencore CEO Ivan Glasenberg, transformed his company from being primarily a trader of commodities into a major producer of them. It also saddled the company with close to $30-billion (U.S.) in added debt and other long-term liabilities.
The Xstrata acquisition was a gamble on China's insatiable appetite for commodities, according to Craig Pirrong, a professor of finance at the University of Houston who has written extensively on the commodity-trading industry. As a result of the deal, Glencore's fortunes are now tied to coal and copper, two raw materials that have been hammered by the recent commodity collapse and by China's slowing economy.
"The more recent data from China have been relatively weak, which exacerbates concerns that those low prices might persist or get even worse," Prof. Pirrong says. "Put all of those things together and with Glencore's [financial] leverage, it's not in a good place."
Analysts' opinions on the company span a huge range, but the majority remain bullish. They say the company can bounce back from its current woes, especially if it can reduce its debt by selling part of the Canadian grain trading operations it acquired through its purchase of Winnipeg-based Viterra Inc. in 2013. The company's debt load "is clearly of concern [but] it is not anywhere near an immediate existential threat to the company," according to Mr. Gait, the Bernstein analyst.
Glencore's biggest asset remains its immense size. It operates in 50 countries, employs 181,000 people, and produces and markets more than 90 commodities. Last year it took in revenue of $221-billion – roughly six times the equivalent figure for Royal Bank of Canada.
What rarely gets mentioned, however, is that all that activity doesn't produce much in the way of profit. Last year, Glencore eked out just over a penny of earnings for every dollar of revenue it took in. Its $2.4-billion in profit may look sizable in absolute terms, but it's only about a third of the earnings that Royal Bank generated on its much skinnier revenues.
In fact, Glencore's profit margin has never been very large. Even back in the palmy days of 2009 to 2011, when it was still primarily a trading firm and China was booming, its profit margin never climbed above 3 per cent, or about what a well-run supermarket might expect to achieve.
Its slender margins are typical for the dozen commodity traders that dominate global trade. Their business is based on carefully managing risks and extracting a small but steady margin from tiny price spreads. "The conventional wisdom around the industry is that margins have become thinner," Prof. Pirrong says. "One explanation is that as information about prices becomes better through the Internet and price reporting services and the like, commodity traders no longer have the information advantage in doing arbitrages that they used to. But "It's always been a thin-margin business," Prof. Pirrong says.
Commodity traders make money using three strategies, Prof. Pirrong says. They ship raw material from places where it's abundant to where it's scarce. They buy commodities when they're cheap and sell them when they're more expensive. Finally, they transform products by processing them – refining metals, for instance, or milling wheat.
Contrary to popular opinion, these strategies don't involve making big bets on the direction of commodity prices. Instead, traders hedge their price risk by buying and selling contracts in the futures market. A trader who has just bought oilseed, for instance, might immediately sell a contract to deliver it three months from now, locking in a spread between the cash price and the futures price.
Done right, hedging means a commodity trader can make money whether prices are rising or falling. But it also means remaining in a relatively low-margin world where competition is stiff.
Glencore hoped to break into more rewarding territory with its move into mining. The goal was to diversify the steady profits from trading with the more cyclical earnings from mining to achieve better bottom-line results for the combined entity.
The problem was that management didn't foresee the extent of the current downturn. "I think Glasenberg had a really bullish view on prices and he acted on that," Prof. Pirrong says.
"The thing they told investors was that they knew this area better than anyone else because of their trading operations, which allowed them to predict prices more effectively. That was baloney, of course."
In effect, Glencore's takeover of Xstrata amounted to an enormous, unhedged bet on metal prices – the complete opposite of what a good trader normally does. The company's comeuppance has been swift.
It lost $817-million in the first six months of this year as coal and metal prices hit multiyear lows. The company's gross debt, meanwhile, towers over $50-billion.
The gap between the non-existent earnings and the enormous debt was the focus of a report on Sept. 28 from Investec, a London-based investment bank, that questioned whether there would be any equity value left in Glencore if commodity prices were to remain low.
Immediately after the report, Glencore shares, which had been fading for months, went into freefall, losing nearly a third of their value in frenzied trading. They have since rebounded but remain volatile.
Mr. Gait, the Bernstein analyst, considers the worries to be overdone. He says Glencore has immediate access to about $13-billion in cash liquidity and does not need to go back to the bond market for funds until 2017. All of that provides ample time for Glencore to deal with its debt problem by selling assets even if commodity prices don't rebound. "[Debt] is an issue that needs to be managed, and that is exactly what the company is doing," he writes.
Mu Li, a base metals analyst at commodity consultant CPM Group, is also sanguine. "I don't share the worries that Glencore is going to default," she says. "It has made great strides in reducing its debt, shutting down mines and making consolidation efforts."
Others aren't so sure. "Glencore's fate is not really in its own hands," Prof. Pirrong says. "What happens to them is up to commodity prices. If prices go up, they'll be okay. If prices stay where they are, they'll bump along. But if prices go down even more, they could have a problem."
Glencore bought Viterra, Canada's largest grain handler, in 2012 for $6.1-billion (U.S.), cementing its status as a commodity-trading powerhouse.
Agricultural products include grain, oilseeds, cotton and sugar. It has facilities for storage, handling and processing.
Glencore plans to sell minority stakes in its agriculture assets, including infrastructure, to strategic investors.
Metals and Minerals
Glencore has interests in copper, zinc, lead, nickel, ferroalloys, alumina, aluminum and iron ore.
Copper assets include operations in Africa – Katanga, Mutanda and Mopani; in Latin America, the Antapaccay mine in Peru, a 44-per-cent stake in the Collahuasi mine in Chile and a 37.5-per-cent interest in the Antamina mine in Peru; and some assets in Australia. Glencore has suspended production at the Katanga and Mopani mines for 18 months.
Glencore plans to sell a "stream" of rights to precious metals produced as byproducts.
Glencore has coal assets in Australia, South Africa and Colombia. Its Optimum Coal mine in South Africa is under "business rescue," which allows a financially distressed company to temporarily delay creditors' claims against it or its assets.
The company said in August it would take a $790-million (U.S.) charge on oil assets in Chad after a fall in oil prices.
Glencore had $23.6 billion worth of production and marketing inventories at the end of June, with the bulk from the marketing business.
Glencore says it cut "readily marketable inventories" by $1.5 billion during the first six months of the year and says it plans further cuts to working capital over the next year.