S&P Downgrades Glencore To Lowest Investment Grade Rating

The one catalyst many Glencore bears have been eagerly waiting for, is the downgrade of the troubled independent energy trader to junk status, a catalyst which as previously explained, will likely spring various, heretofore unknown margin calls and collateral "waterfalls" a la AIG.

Overnight, one of the two rating agencies, Standard and Poors, came one step closer to that fateful moment when it downgraded Glencore, however it decided to throw the company one last lifeline by keeping it at the very lowest investment grade rating, and instead of cutting it from BBB to single B or CCC where its CDS and bond yield implies the company should be trading, it kept it a BBB-.

This is what it said:

Glencore PLC Ratings Lowered To 'BBB-/A-3' On Price And Sector Review; Outlook Stable

  • Standard & Poor's Ratings Services has recently lowered its price  assumptions for copper and other metals, reflecting the very challenging  market outlook and the increased uncertainty about demand. 
  • These heightened operating risks, reported EBITDA declines, and increased volatility of earnings lead us to a more cautious assessment of global mining company Glencore PLC and its financial leverage.
  • We are therefore lowering our long- and short-term corporate credit ratings on Glencore to 'BBB-/A-3' from 'BBB/A-2'.
  • The outlook is stable as we believe Glencore's meaningful continuing free cash generation, strong liquidity, and active balance sheet deleveraging should mitigate downside risk.

Standard & Poor's Ratings Services  today said it has lowered its long- and short-term corporate credit ratings on global diversified mining and trading company Glencore PLC to 'BBB-/A-3' from  'BBB/A-2'. The outlook is stable.

We also lowered the rating on the debt issued or guaranteed by Glencore and  Glencore International AG to 'BBB-' from 'BBB'.

The downgrade reflects both our view of the material challenges the mining industry faces, with increased uncertainty about future operating performance in 2016 and 2017, as well as our assessment that Glencore's 2015 financial profile was below our earlier expectations with funds from operations (FFO) to debt closer to 20%, notwithstanding material debt reduction. This compares to a range of 23%-28% which we previously saw as commensurate with the 'BBB' rating. The rating action follows a modest negative re-evaluation of both business and financial factors for Glencore, as reflected in our negative comparative rating assessments. We believe the 'BBB-' rating has more sustainable headroom, particularly in the prevailing low price environment, and we anticipate significant further debt reduction in 2016.

We recently lowered our price assumption for most commodities, including some of the key commodities for Glencore, such as copper, zinc, and nickel (see "Standard & Poor's Revises Its Price Assumptions For Metals On Continuing Price Weakness," published on Jan. 22, 2016). This was after metal prices came under pressure because of fears of lower demand from China, combined with excess supply. We believe that commodity prices will remain very unsettled while the impact of China's slowdown plays out. This environment results in reduced visibility of future profits for Glencore and its peers. For Glencore, in particular, this also has, and may continue to result in, greater reported earnings volatility than we had previously anticipated, even if we recognize the relative stability over time of trading profits compared with those from mining activities. Glencore's EBITDA in the first half of 2015 was down 29%, broadly in line with BHP Billiton and Rio Tinto.

Nonetheless, under our revised base-case scenario, we project that Glencore's FFO to debt is likely to recover to above 23%-25%, although this is dependent on our price, foreign exchange, and other assumptions including the company's December 2015 guidance for lower unit costs and capital expenditure (capex). Critically, we foresee continued delivery of Glencore's debt reduction plan in 2016 and, in our view, likely disposals in the near term, as well as forecast free cash flow from operations of $2 billion-$3 billion, supported by expected resilient trading profits.

Our forecast of reducing leverage is also underpinned by the debt reduction plan of more than $10 billion that Glencore has been delivering since September 2015. This included a $2.5 billion equity raise, cancellation of the 2016 dividend payments, the further release of working capital, and other steps including disposals.

Key assumptions in 2016 and 2017 include:

  • Annual copper production of 1.4 million tonnes-1.6 million tonnes at prices of $2.1 per pound (/lb)-$2.2/lb;
  • Annual zinc production of 1.1 million tonnes at prices of $0.7/lb-$0.8/lb;
  • Marketing EBITDA of $2.7 billion;
  • A moderate net working capital release of $0.5 billion-$1.0 billion;
  • Capex of $3.5 billion-$4.0 billion;
  • No dividends; and
  • Disposals of $1 billion-$2 billion.

Under our baseline, these assumptions result in proportionately consolidated EBITDA of $7.0 billion-$8.0 billion in 2016 and just over $8.0 billion in 2017, compared to $13 billion in 2014. Consequently, we foresee FFO to debt improving to over 23%-25% in 2016 and possibly approaching 30% in 2017.

The stable outlook reflects our assessment that Glencore's meaningful continuing free cash generation of over $2 billion, strong liquidity, and active balance sheet deleveraging should support the ratings, even in a modestly weaker commodity price environment than our base case assumes. We believe FFO to debt consistently over 20% is compatible with the ratings. We expect rating headroom to materially increase over the coming quarters, as we anticipate significant further debt reduction through disposals. Glencore is targeting disposals of at least $3.0 billion-$4.0 billion, which the company has been delivering since September 2015.

We see the potential for a negative rating action as low, given the expected continued deleveraging in 2016-2017, supported by management's strong commitment to strengthening its credit metrics and decisive actions to date. Key risk factors would stem from a further prolonged fall in commodity prices, notably if economic developments in China worsened and absent material offsetting factors. A downgrade of Glencore would become likely if FFO to debt remained below 20%. As an example, we estimate that if copper prices averaged below about $1.8/lb over 2016 and 2017, it could be difficult for Glencore to maintain FFO to debt above 20% without compensating measures or factors such as foreign exchange.

Rating constraints could stem from a material acquisition, without comparable offsetting disposals, or a more fundamental adverse reassessment of the resilience of the business mix and profile compared with peers.

The likelihood of an upgrade could increase if we perceived a sustainable improvement in the mining operating environment and Glencore's earnings performance is stable. We could consider a positive rating action if we anticipate that FFO to debt will remain comfortably above 23%, while seeing continued positive discretionary cash flow.

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To summarize, this is what according to S&P, represents an investment grade rating:

 

And now we look forward to Moody's to likewise downgrade Glencore, although we won't be holding our breath: as a reminder, back in December Moody's already downgraded GLEN to Baa3, the lowest IG rating there is: any more downgrades would automatically mean the start of any latent junk "waterfalls" that may be hidden deep in the company's $100 billion in total liabilities.

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