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Investors who stayed with Xstrata for the ride of the merger with Glencore will hope good things really do come to those who wait. One week into trading of the commodities trader and miner, and shares have gained 4 per cent. That is less impressive when considering that Rio Tinto and BHP Billiton, for example, have gained the same and more, respectively. It is hard not to believe that the commodities cycle has taken a downturn as China, the world's largest consumer of resources, has shifted down a gear to sustainable growth. Will Glencore Xstrata prove one of the successful survivors? It has some trump cards on its side.
First is the trading division inherited from Glencore. Underlying profit at the group fell less than peers in 2012 as trading earnings rose 11 per cent against a 27-per-cent fall in mining. Glencore Xstrata expects trading to generate about a third of earnings in the future. Trading's targeted 40- to 65-per-cent return on equity is impressive, but remember that this business is boosted by leverage – three to four times net debt to earnings before interest, tax, depreciation and amortization, according to Bernstein's calculations. That measure of gearing is usually around one for big mining companies.
And in the mining side of the new group, chief executive officer Ivan Glasenberg is determined to be ruthless on costs, particularly on middle layers of management. He has also been vocal about shunning the mega projects beloved by the likes of Rio Tinto. It is likely that more than the $500-million in touted synergies can be achieved. Beyond that, Glencore Xstrata is a punt on coal and copper – the two account for two-thirds of mining revenues. It trades on 11 times forward earnings, above Rio but below BHP on 13 times. That sounds right for a merger with still so much to prove.