The question for investors is: Should Monday’s 27% fall in the Glencore share price and its more than 75% capitulation year-to-date be seen as a warning sign of what is to come for the broader market, or is it a unique case.
In other words, should it be seen as the final oxygen-starved gasp of the suffocating bird in the idiom, or is it merely the weight of its debt that is choking the life out of it?
For Investec’s Hunter Hillcoat the answer is, in many ways, a combination of both. In a note out on Monday, which many cite as the catalyst for Monday’s drop, he writes that should commodity prices not improve in the short term, those miners with substantial debt piles could see much of their equity value disappear.
He explained the problem is that mining companies gorged themselves on cheap debt in a race to grow production following the Chinese stimulus that occurred in the wake of the global financial crisis, but mines take a long time to build. And, in the current climate of low prices and an uncertain growth outlook for China, “debt is fast becoming the most important consideration for mining company management”
““Never underestimate the ability of debt to undermine the value of equity,” neatly sums up the problem that equity holders face when considering how the highly leveraged companies, such as Glencore, see their much diminished earnings absorbed by the obligations to debtholders,” he adds.
According to Hillcoat, should commodity prices not recover, “the value for Glencore and Anglo American equity holders is virtually eliminated given sustained depressed earnings, particularly in Glencore’s case as a consequence of its higher debt base, the recent refinancing notwithstanding”.
But, he adds, while the situation is less extreme for BHP Billiton and Rio Tinto, their commitment to maintaining their respective dividends could see them too face tougher times.
“We suspect Glencore’s recent restructuring may prove just the start for the majors if current spot prices prevail for much longer, and this serves to support our concern that we are still a distance away from a “value point” in the mining sector,” he added.
