Update: even the rating agencies finally noticed - S&P: GLENCORE TO BBB/NEGATIVE FROM BBB/STABLE
Next stop: junk, and 500bps+ CDS
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Back in March of last year, when previewing the events that have rocked the world over the past month (because nobody, nobody could have possibly anticipated the Chinese economic crash and the concurrent commodity tumble which are just two sides of the same bursting credit bubble coin) we wrote "Is This The Cheapest (And Most Levered) Way To Play The Chinese Credit-Commodity Crunch?"
We were referring to Glencore credit default swaps (i.e., default risk), which trading at just over 150 bps, were, from an upside/downside and every other perspective, the cheapest, most levered and most attractive risk bet to trade the upcoming Chinese/commodity crash as a result of Glencore massive exposure to the price of copper, which in its own words stood to lose over $1 billion in EBIT for every 10% move in the price of copper ...
... a sensitivity few had realized.
Fast forward to two weeks ago when the same day the Fed leaked its FOMC minutes and in the process unleashed the recent market correction, we wrote "The Next Leg Of The Commodity Carnage: Attention Shifts To Traders - Glencore Crashes, Noble Default Risk Soars" and finally, well over a year after we first introduced Glencore as the fulcrum anti-China trade, the investing public finally started to notice.
When we wrote our Glencore update on August 19 , GLEN CDS had soared from its baseline level of about 150 bps to north of 300bps, even as the stock kept sliding as show in the chart below.
In the past two weeks things for Glencore have gone from bad to worse, and as of today, the stock closed at an all time low of just 122.8p, dropping another 8%, following a 10% drop the previous day - the worst two-day drop in the stock price since going public - and taking its all time loss since its 2011 IPO to a whopping 75%!
Why the drop? Yesterday Bank of America released a report looking at global miners in attempting to answer the question whether "the miners are cheap enough yet", in which it posed the question how much new equity do miners needs. Its answer: $50 billion now (up to) $60 bn. It added that, "as in April, we believe early “recappers” could be rewarded with less dilution, premium market ratings and possibly a “license” to undertake M&A."
That's for the industry in total, what about just Glencore? BofA looked at several scenario, most notably the "baby bear" (in which commodities and currencies dropped another 20%) and a "doom and gloom" (a 33% drop) and said that "Glencore has limited equity value in our “Doom and Gloom” scenario. We think this is consistent given 1) fairly high financial leverage and 2) some assets are not particularly low cost. For us, this confirms what most investors already know about GLEN, it is something of a “bull call” on commodity markets."
BofA adds that Glencore, which has $30 billion in net debt on $9 billion of EBITDA, has a $12 billion capital shortfall if the company were to hit a target 2.0x leverage, and just over $3 billion if the leverage was stretched to 3.0x.
Putting these numbers in context, BofA estimated that Glencore has 25% downside to the base case and 64% downside to the "Baby bear" scenario. Under the "doom and gloom" case Glencore would go bankrupt.
The end result of all these considerations is what equity investors, realizing that the overlevered company would have to issue a lot of stock just to preserve equity value - it is questionable whether and at what price it could pull this off - decided to sell first, and ask questions later, pushing the stock down by nearly 20% in the past 2 trading days.
And while an equity offering would be perfectly expected given the company's financial and cash flow plight, what is extremely confusing is that earlier today Glencore announced that instead of shoring up capital, it would part with some $350 million in much needed capital announcing it would pay back $350 million of perpetual bonds next month, "showing the company has cash to pay debt as it battles a commodity price slump and a slowdown in China" according to Bloomberg. "The commodity trader and miner headed by billionaire Ivan Glasenberg, will redeem the 7.5 percent securities on Oct. 6, the earliest date possible, it said in a statement to the Luxembourg stock exchange. The notes will then be canceled, it said."
“It’s a little signal from management that Glencore is comfortable with the cash profile it has despite everything that’s going on,” said Rick Mattila, head of strategy and research at Mitsubishi UFJ Securities International Plc in London. The company doesn’t “feel the need to leave this outstanding, and save themselves $350 million of liquidity.”
Management may be comfortable, but shareholders certainly weren't, the result being Glencore's stock hitting fresh all time lows. And, not unexpectedly, neither were bondholders, because as a result of the cash outflow there was net selling across the entire capital structure, with CDS pushed another 18 bps wider just why of 400 bps.
Which, incidentally, remains the best way to trade a company which still remains largely misunderstood, because at its hear, Glencore's problem is not a capital structure one, nor even a purely debt one (although debt is certainly a major concern), but one of cash flow, or rather the collapse thereof, because should copper (and all other commodities) continue to trade at current subdued levels, the bigger question will be not whether GLEN can issue stock to keep itself viable, but how much the debt-to-equity exchange will have to be in the coming year, to cram down the stock and restructure the debt which is now longer feasible for the current contractionary global phase.
Which is why, while the stock may stage a violent rebound here purely on short selling, we remain convinced that GLEN CDS, which we loved at 150 bps, is still the way to trade not only the inevitable downfall of Glencore equity, but the Chinese and commodity crunch as well.
This can be seen especially when comparing just the recent violent move lower in the stock to the (still) relatively muted blow out in Glencore CDS.
Expect much more from not only this name, but from its peers Trafigura, Mercuria and of course, the company we are all keeping a very close eye on: Asia's biggest commodity trade, Noble Group, profiled here previously.