After last week’s major announcement, we are back to comment on Glencore (OTCPK:GLCNF) (OTCPK:GLNCY). As a reminder, this is not the first time we have checked the mining company operations and its M&A optionality. In early June, we published an analysis called “M&A Risk Offers A Possibility To Enter,” in which we emphasized how:
Glencore proposal was more effective in unlocking synergies between Teck and Glencore coal mines with the idea to create a newCo combining the companies’ non-ESG division to build a player large enough to fund its growth. In detail, the proposed deal would involve the combined thermal and met coal segment and the ferrochrome operations.”
Glencore – Teck Update
No sooner said than done. In the year, Teck declined the merger combination offers; however, last week, Teck finally announced the entire sale of its EVR division. 77% will be acquired by Glencore, with the remaining 23% to Nippon (20% – Japan) and Posco (3% – Korea). The deal with Nippon Steel and Posco is expected to close in Q1 2024, while the transaction with Glencore is expected to close in Q3 2024. On a regulatory basis, the Nippon Steel and Glencore transactions are not inter-conditional; however, they are both subject to regulatory approvals and the Investment Canada Act & Competition office. Looking at the Glencore detail, the company will control the majority stake for a total cash consideration of $6.9 billion, implying a full valuation of $9.0 billion on a 100% basis. As we already mentioned, this was the only positive outcome for Glencore because it triggered an eventual Coal Company spin-off. Glencore is one of the few large groups active in the coal business. In recent years, many mining corporations reduced their exposure to this commodity, following pressure from investors, governments, and consumers, all willing to minimize greenhouse gas emissions. Even if Glencore stated that it intends to close these activities by 2050, we believe this deal will unlock significant shareholders’ value. The coal division has lower CAPEX and higher FCF, which will translate into a substantial cash cow.
Elk Valley Resources (EVR) interests are related to mining in Line Creek, Greenhills, Fording River in Southeast British Columbia, and 46% of Neptune Terminals in North Vancouver. In detail, EVR steelmaking coal output was 21.5mt in 2022. Year-to-date, the division has produced 17.3mt. Cross-checking the numbers, EVR EBITDA reached USD Canadian 7.4 billion in 2022. Year-to-date, we are at USD Canadian 3.7 billion, with profit before tax at 6.0 billion and 3.1 billion in the two respective periods. As of September-end, EVR gross assets were at 18.5 billion. Looking at the consensus numbers, the implied EV/EBITDA deal multiple is 3.8x and 5.5x in 2024 and 2025. However, following the Teck adjustment on corporate costs, the multiples should be 3.5x on our internal estimates.
As a part of the deal, the company committed the following: 1) leaving the head office in Vancouver and all the related Canadian regional offices, 2) no employee reduction, 3) higher investment in the region with CAPEX to USD Canadian 2 billion (excluding deferred stripping) over the next three years, 4) higher investment in R&D activity for a threshold of USD Canadian 150 million in the next three years, and 5) lowering scope 1 and 2 emissions with net-zero targets by 2050.
Glencore Upside and Valuation
Here at the Lab, we like the coking coal optionality and Glencore pathway to separate its coal assets completely. The company intends to demerge the business once it has sufficiently deleveraged. This could be achieved by H1 2025. According to the company, Glencore will manage to have a balance sheet with $5 billion net debt, down by the current $10 billion. Looking at the press release, the new CoalCo division “would be well positioned as a leading, highly cash generative company, likely attracting strong investor demand given such yield potential.” Despite the positive news, investors are uncertain about demerger time upon market conditions. With deleveraging in process, this latest transaction might unlock shareholders’ value. In number, our combined coal business activities reached an aggregate EBITDA of $5.8 billion in 2024.
Looking at Glencore valuation, we see little downside pressure on the company’s valuation due to the coal assets investment. Excluding coal assets, the Glencore Metals business is now 80% dominated by Marketing and Copper. This represents ~80% of the total company’s valuation. If these assets were rated on similar peers such as SCCO and FCX, Glencore should trade between 8x and 10x EV/EBITDA multiple. Glencore high-quality assets cannot go unnoticed, and the marketing division is a real earnings differentiator, providing supportive cash generation in the downside cycle. Industrial EBITDA is now forecasted at €8.8 billion in 2024. Despite that, we believe that Wall Street will be skeptical of the company’s ability for the upcoming operational challenges. Looking at the recent Q3 production report, the full-year production outlook was left unchanged for “copper, zinc, coal and cobalt.” At the same time, it was reduced for nickel to reflect higher maintenance outages. However, this was fully offset by the marketing activities segment, which continues to have an outcome above the top end of Glencore’s internal guidance. Valuing the coal business with a 3.5x EV/EBITDA multiple (for a valuation of $20.30 billion) and combining the Glencore Metals business with a 5.5x EV/EBITDA (for a valuation of $70 billion), we arrived at an enterprise value of almost $90.30 billion. Deducting the year-end net debt estimated at $28 billion, our target price is £5 per share. Therefore, we confirm our buy rating target. Downside risks include a slowdown in economic activities (with a particular emphasis on real estate and industrial production), further GDP cuts, lower output prices (especially in copper), value destruction M&A, ESG downside pressure, and regulatory risks (M&A approvals, licensing, and permission).
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