Slump puts Glencore’s credit rating at risk
GLENCORE is doing everything from selling assets to ditching the dividend to retain its credit rating, but there is one big thing the company cannot control: commodity prices.
Metal prices such as copper and nickel underpin models that Standard & Poor’s (S&P) and Moody’s Investors Service use to determine Glencore’s creditworthiness and currently prices are below assumptions. While the company last month unveiled a plan to reduce debt by $10 billion (R138bn), the ongoing slide in commodity prices poses a challenge to its credit metrics, according to analysts at the ratings firms.
“Are the measures enough? Yes, in the sense that we’ve affirmed the rating but clearly there is a scenario where commodity prices remain very low for a long time,” S&P analyst Simon Redmond said. “Some commodity prices are currently below our assumptions and that is going to put some headwinds in terms of an improving trajectory.”
Preserving its credit ratings, the second-lowest investment grade at S&P and Moody’s, is critical to Glencore because the company borrows heavily to sustain trading, which accounts for almost a third of earnings. To bolster its balance sheet, Glencore has hired banks to sell a minority stake in its agricultural business and is planning to sell future production of gold and silver, according to people familiar with the deals.
Copper prices
S&P’s assessment of Glencore rests in part on copper at $2.40 a pound this year for a BBB rating. Moody’s Baa2 rating is based on $2.50 a pound. The metal, which makes up 28 percent of Glencore’s earnings, is now trading at $2.30 a pound. Coal, zinc and nickel are also priced below the assumptions.
Ratings firms rely on average prices over the medium to long term to make their judgment and there are many factors within Glencore’s control that can be used to reduce debt. S&P and Moody’s said last month that Glencore’s plan to cut debt was a positive sign and affirmed the current ratings.
A Glencore spokesman declined to comment beyond Tuesday’s statement, which said the company had “positive cash flow, good liquidity and absolutely no solvency issues”.
Glencore would probably keep the investment-grade rating because S&P and Moody’s would probably provide a “grace period” to complete the asset sales and restructuring, JPMorgan Chase analysts said in a report. Even if prices stayed the same, it could mitigate the concern around its credit rating and meet its debtreduction goals, they said.
“Although we do not expect an imminent formal downgrade by the agencies, equity markets will likely continue to price in the impact of a downgrade”, unless commodity prices improved or the company cut debt more quickly, according to the note from JPMorgan.
Given the recent level of commodity prices, the company would need to increase its debt-reduction target by $4bn on top of the $10bn planned, Macquarie Group analysts wrote in a report this week.
While the stock plummeted 29 percent in London on Monday, it has recouped the loss in the past three days after the company said it was reducing debt and had no solvency issues.
Distress
In Johannesburg, Glencore’s shares lost 2.66 percent to close at R18.65 yesterday.
Credit analysts from Barclays said a meeting they organised with members of Glencore’s management on Wednesday had addressed many concerns of investors and bondholders.
“The market is telling us that Glencore is in financial distress. Our credit colleagues believe this is premature and do not have those concerns – they do not think Glencore is at risk of imminent default,” Barclays analysts said in a note, adding that they believed the company could retain its investment-grade credit rating.
Glencore market jitters were triggered by worries that if the collapse in commodities prices over the past year persisted for too long, it would stretch the company’s ability to earn enough to service its debt.
Glencore has already pledged to cut its net debt to $20bn from $30bn, by selling assets, reducing expenditure, suspending dividend payments and raising $2.5bn of new equity capital with the share sale completed last month.
The Barclays analysts said Glencore told the meeting it had $50bn worth of credit lines from banks but had so far used only 30 percent of these.