Morning Note: Market news and an update on miner Glencore.

Market News

US equity markets moved lower last night: S&P 500 (-0.6%), Nasdaq (-0.9%). Amazon rose post-market on the announcement it will replace Walgreens in the Dow. Separately, Jeff Bezos sold another $2.37bn of shares. The 10-year Treasury currently yields 4.28%. The Fed may keep shrinking its balance sheet even as one of its key liquidity facility runs low, analysts said. FOMC minutes will offer insight about how much additional confidence officials need in the disinflation narrative before they’ll start cutting rates, Bloomberg Economics said.

This morning in Asia, markets were mixed: Nikkei 225 (-0.3%); Hang Seng (+1.6%); Shanghai Composite (+1.0%).  China’s quants face a clampdown as the two key mainland exchanges vowed to tighten oversight after freezing the accounts of a major hedge fund for three days.

The FTSE 100 is currently trading 0.7% lower at 7,666. HSBC has been marked down by 7% as it reported annual profit below market forecasts and a $3bn charge from its stake in a Chinese bank.

Lower borrowing costs have given Jeremy Hunt an extra £10bn for pre-election tax cuts in his budget next month, the Resolution Foundation said. Total headroom of £23bn would give him the firepower to cancel the planned 5p increase in fuel duty and knock two percentage points off the 20% basic rate of income tax. Sterling trades at $1.2615 and €1.1672.

Brent fell to $81.30 a barrel. The combined assets of the world’s four biggest long-oil ETFs hit the lowest since September 2022 this week. Gold held steady at $2,027 an ounce.

Company News

Glencore has this morning released its 2023 results which highlight the negative impact of lower commodity prices on profitability. With spending on acquisitions to come, the group has not announced a new share buyback programme. The shares have been marked down by 4% in early trading.

Glencore is a vertically integrated commodities business, with a strong position in the production of copper, thermal coal, nickel, zinc, cobalt, and precious metals, and a unique marketing business which markets and distributes commodities sourced from internal production and third-party producers to industrial consumers. The group’s strategy is to own large-scale, long-life, low-cost Tier 1 assets.

Glencore is a leading producer of metals that are used in low-carbon and carbon-neutral technologies, such as electric vehicles and renewable energy, the outlook for which is underpinned by robust demand and persistent long-term supply challenges. The IEA estimates that by 2050 the metals requirement for clean energy technologies will amount to 2.1x-3.4x more copper than in 2020, 10.8x-30.1x more nickel, and 9.9x-32.9x more cobalt. Given the industry’s supply constraints, the group is also increasing its investment in recycling and circularity. Glencore also has a potential 10% equity stake in Li-Cycle (recycling and processing of lithium-ion batteries) via a $200m convertible note.

Last November, Glencore announced an agreement to acquire a 77% interest in Teck’s steelmaking coal business (Elk Valley Resources) for $6.93bn in cash. The remainder of the company will be owned by Nippon Steel (20%) and POSCO (3%). The transaction is expected to close in Q3 2024. The assets will complement Glencore’s existing thermal and steelmaking coal production located in Australia, Colombia, and South Africa. The company believes global population growth, increased urbanisation, and a growing middle class should continue to drive long-term demand for steel and the steelmaking coal required to produce it. Glencore’s intention is to demerge its combined coal business once the company has sufficiently delevered, which is expected to occur within 24 months from close. The company will continue to oversee the responsible decline of its thermal coal operations in line with Glencore’s current targets.

Now to the results. Commodity prices trended lower in 2023 due to the impact of higher interest rates on consumer and industrial demand and more normalisation of energy markets from 2022’s extreme disruption. As a counterweight, increasing demand in China, supported by the energy transition and related infrastructure investment, was instrumental in offsetting softer demand in developed markets, keeping most key commodity prices at levels well above prior cycle lows. Against this backdrop, the company posted a lower, albeit healthy, earnings performance, with adjusted profit (EBITDA) down 50% to $17.1bn.

The Industrial assets’ EBITDA fell by 52% to $13.2bn. Metals fell by 41% to $5.4bn, reflecting lower realised cobalt (-50%), nickel (-16%) and zinc prices (-24%), and reduced volumes. Copper only fell by 4%. Energy declined 55% to $8.5bn, mainly due to significantly lower coal prices (Newcastle grade thermal coal, -52%). Safe haven commodities such as gold rose by 8%.  Inflationary cost impacts were seen across the asset base, much of it having lagged and been heavily influenced by the surge in energy prices during 2022. The company highlights cost headwinds are now moderating.

Glencore’s marketing business exploits arbitrage opportunities that continuously emerge in commodity markets. It provides a good hedge against commodity price volatility and finances the $1bn base dividend (see below), although clearly there is always a risk of potential losses because of that volatility. In 2023, the unit generated adjusted profit (EBIT) of $3.5bn, down 46% from last year’s exceptionally strong performance, but above the $2.2bn-$3.2bn p.a. long-term guidance range.

Capital expenditure grew by 22% to $5.6bn. Guidance for the next three years is an average of $5.7bn p.a. The company is looking at greenfield mine developments, although these projects will only be approved when the market requires the commodity (and prices are higher) or when existing projects are completed. Funds from operations fell 67% to $9.5bn. Net borrowing rose from $0.1bn to $4.9bn, with gearing a comfortable 0.29x net debt to EBITDA.

The dividend policy is to pay a fixed $1bn base distribution from the Marketing business, reflecting the resilience, predictability, and stability of the unit’s cash flows, plus a minimum payout of 25% of Industrial free cash flow. This morning, for 2024, based on 2023 cash flows, the group is recommending a 13c per share (c. $1.6 billion) base cash distribution, comprising $1bn from Marketing cash flows and 25% ($0.6bn) of Industrial attributable cash flows.

Where net debt falls below the group’s net debt cap (after the base distribution), cash will be periodically returned to shareholders via special cash distributions and/or share buybacks as appropriate. Since 2020, the group has announced $10.3bn of “top-up” returns.

Following the EVR announcement, the group is now managing its balance sheet around a revised $5bn net debt cap (vs. $10bn previously). Given net debt is currently $4.9bn (with the $6.9bn Teck acquisition to come), there are no “top-up” returns at this point. However, the business is expected to be highly cash generative at current spot commodity prices – annualised free cash flow generation would be $5.2bn (an 8.5% FCF yield) from adjusted EBITDA of $15.0bn. The company says this augers well for top-up returns to recommence in the future.