Glencore Has an Achilles Heel That Will Hurt It

Glencore [stock_market_widget type="inline" template="generic" color="default" assets="GLNCY" markup="(OTC: {symbol} {currency_symbol}{price} ({change_pct}))" api="yf"] started the year brightly but it has fallen prey to the weak commodity pricing environment prevailing across the globe. The commodities giant is currently trading close to the lower end of its 52-week range and a turnaround might not be in the cards. Let’s take a closer look at the reasons why Glencore might not be turning around anytime soon.

Cobalt Is in a Tailspin

At the end of July, Glencore announced that the halving of cobalt prices is having a substantial negative impact on the company’s business, dealing a $350 million blow to the company. As it turns out, cobalt prices have dropped from $60,000 per tonne at the end of last year to less than $30,000 per tonne of late.

So, even though Glencore managed to deliver a massive 28% boost in cobalt output, the huge decline in prices led to earnings before interest and tax loss of $350 million from the commodity. The steep decline in cobalt prices can be attributed to the fact that the initial growth driver – electric vehicles – did not live up to expectations.

Meanwhile, China, which is the world’s largest cobalt consumer, stockpiled the commodity and created an inventory glut. Because of all these reasons, cobalt prices have come crashing down and caused pain for Glencore.

But there is still hope for Glencore as it is believed that demand for cobalt could get better in the coming days, though that’s dependent on electric car adoption. As reported by Reuters:

“Demand for metals used in battery electric vehicles could rise sixfold if electric cars reach 8% of road traffic by the mid-2020s, delivering huge dividends for producing countries like Democratic Republic of Congo, Moody’s said on Tuesday.”

So it remains to be seen which direction cobalt prices take in the future as that will be the key to Glencore’s performance.

An Expensive Stock

Though Glencore is trading at the lower end of its 52-week range, the stock is expensive with a trailing price-to-earnings ratio of nearly 40. That’s double the company’s five-year average price-to-earnings multiple of 18.

Given this premium valuation, it does not make sense to buy Glencore stock given the challenges that it is facing. Moreover, investors should not forget that Glencore is a highly-levered stock with a debt of nearly $36 billion. By comparison, its cash position is extremely thin at just over $2 billion.

Depressing business conditions could create pressure on the company’s cash flow and dividends thanks to a high-interest burden. As such, making a bet on Glencore without the presence of concrete catalysts does not seem to be a good idea at this moment.

Harsh Singh Chauhan has a wealth of experience evaluating publicly-traded companies across several verticals, including technology, oil and gas, retail, and consumer goods. His financial writing has been published across platforms such as The Motley Fool, TheStreet, and Seeking Alpha. Harsh's philosophy is to find great businesses for the long run based on company fundamentals and industry prospects. Address: 682 Indian Road, Toronto, Ontario, M6P 2C9. Phone: 416-721-8257.


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