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Glencore Xstrata: Commodity Prices and Merger aftershocks

When Glencore and Xstrata merged, it created the fourth largest mining company globally and an integral part of many commodities’ supply chains. It looks now however that Xstrata was overvalued and the company could be facing an $8bn loss on mining assets due to weaker conditions in the commodity industry.

Following the 16-month acquisition saga, in the company’s first set of results saw a 2% dip in revenue for the first of 2013 compared to last year, and a 9% drop in EBITDA. Two significant macroeconomic events have contributed to Glencore’s dimmed performance. With China accounting for a considerable proportion of global commodity demand, any deceleration in the Chinese economy will resonate throughout the world. Furthermore, with the Federal Reserve positioning itself to gradually end quantitative easing, this has caused widespread economic uncertainty.

Commodity metal prices fell on average 15% in H1 2013, and weakening demand has wiped billions of mine sites’ prospective values. The S&P 500, has been a 13% rise, however, helping to improve some of the company’s assets. Glencore Xstrata’s diversified business strategy has helped to ameliorate the impact of falling commodity prices, with their marketing operations pro forma EBIT increasing their revenue 6% compared to H1 2012. This was not enough however, to compensate for a steep decline in their Industrial activities, which fell 39% to $2bn. Nickel and aluminium operations have suffered, with a $452m hit on its Australian Nickel mine.

Despite the plummeting prices, the company seems to be coping well; broadly metals and coals improved their output and efficiency. The price drop is not just affecting Glencore Xstrata; mining competitor BHP Billiton announced a 30% fall in annual profits. Agriculture’s sluggish start to the year has masked encouraging underlying factors, as the Viterra acquisition’s benefits are accruing. The synergies of the merger gradually being realised, utilising Xstrata’s ferocious capacity to cut costs, and integration of their overlapping distribution networks (Glencore already sold a considerable amount of Xstrata’s products). They now predict the cost savings would exceed the original target of $500m a year.

The company is currently evaluating its assets, (most likely Greenfield projects) and judging their future value.  Sites currently under scrutiny include the $5bn stake in Peruvian copper mine Las Bambas (although this was demanded by the Chinese government to ratify the merger), and the $5bn nickel operation Koniambo in New Caledonia. It insists it is in no rush to start the sale.

The company is also seeking a fulltime chairman to succeed interim appointment Tony Hayward; the former BP CEO who gained notoriety during the Mexican Gulf Oil spill to the point of satirical mockery by the television programme South Park. CEO Ivan Glasenberg remains adamant that he will remain at the company.

The deceleration of the Chinese economy has had serious ramifications for this integrated commodity company, along with merger teething problems. Nevertheless, the company’s underlying performance exhibits solid performances given the current climate. Xstrata’s tenacity in cost cutting is being realised to the company’s delight. The diversified nature and unsynchronised markets in which they have diversified should provide some panacea to their aliments, but inevitably will rely on a surge in Chinese demand to return to previous revenue and profit levels. It is well positioned for an upturn.  The company’s ruthless opportunism suggests that they will perform admirably regardless of trading conditions. There should be no illusions that in a company where its director of agriculture trading, Chris Mahoney, once described an international food crisis as a good environment for trading with, “a lot of arbitrage opportunities” will not struggle to make profits.

Marketline previously assessed the impact of the Glencore Xstrata merger. See our Case Study ‘Glencore & Xstrata: Creating the fourth largest global mining company‘ for more details.

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