The two stocks in question – Glencore and Imperial Tobacco – had very different fortunes on Wednesday, but together would seem to underline a point about the market that is becoming finer with every day: there is a lot more downside in stocks than upside.
In the red corner is Glencore, whose stock slumped 8% on Wednesday after it announced a 53% decline in earnings per share on the back of cratering commodity prices.
But, while poor, the results we not unexpected as commodities prices have been weak for some time. Indeed, Liberum pointed out in a note, the miner’s interim results came in largely in line with recently downgraded consensus: “EBITDA of $4.6bn vs consensus $4.9bn.
And, looking through the numbers, while earnings were sharply lower, so too were expenses. The firm announced it had managed to cut $400m in costs out of the business to date and is targeting a further $400m in savings and efficiencies over the course of the next 12 months. It also reduced its capex expenditure 21% to $3.2bn and lowered net debt by 3%.
If the earnings weren’t a particular surprise, and cost cuts continue, why would the shares be down as much as 9% on the day? One reason has to do with debt. While it has reduced its debt pile more than analysts were expecting, significantly more is still needed on that front. As Liberum explained: “Management plans to reduce it to $27bn by year end. Given the weak earnings outlook this will be essential to maintain the dividend, as the company must maintain an investment grade credit rating for its marketing business, putting significant restrictions on cashflows.”
But, perhaps the more important reason is the mining sector’s significant reliance on China in recent years and current worries over the country’s ability to continue to grow and consume commodities.
The big problem is no one has a clear view of what demand from the region is going to be going forward, which makes it very difficult to be positive on the mining sector. Indeed, as Morgan Stanley pointed out recently, the sector’s average valuation is currently around a 15 year low and is approaching the record trough it reached in 1998.
Not even Glencore CEO, Ivan Glasenberg seems to have a view, telling Bloomberg on Wednesday: “At the moment none of us can read China. None of us know what is going on there and I’m yet to find the guy who can predict China correctly. China in the first half was a lot weaker than anyone expected.”
