Glencore's Credit Rating Under Strain If Copper Remains Down

  • Company will be rated junk if copper stays below $2.10/lb: RBC
  • Glasenberg to provide update on debt-reduction plans next week

When Glencore Plc meets with shareholders next week, one big question on the minds of investors will be how long the company’s credit rating can withstand an ongoing slide in commodity prices.

Copper is 18 percent below the price used by Standard & Poor’s to assess its BBB rating for Glencore, one of the largest commodity traders. While S&P says below-estimate prices don’t mean a downgrade is imminent, the gap highlights how quickly metals prices have fallen and the headache it brings for producers with lots of debt.

“If current spot prices persist over the next couple of years, then that’s going to make it more difficult for the company to keep credit measures in-line with our expectations,” Simon Redmond, an analyst at S&P, said in a phone interview from London. “There could come a copper price at which the current rating becomes unsustainable.”

With the company’s balance sheet bearing $30 billion in debt and no sign of a turnaround in metals, Chief Executive Officer Ivan Glasenberg is under pressure to deliver on a $10 billion debt-reduction package. During the Dec. 10 meeting, executives are expected discuss asset sales, cost cuts and other measures designed to reduce the company’s debt burden, the biggest in the industry.

S&P’s copper price assumption (red) is $2.55 a pound for 2015 while Moody’s (green) is $2.50 a pound.

Copper is having the worst year since the financial crisis of 2008 as prices lost 26 percent amid weakening demand from China. The metal touched a six-year low last week of $2.002 a pound in New York. That’s 20 percent below the $2.50 a pound estimate for 2015 used by Moody’s Investors Service and 21 percent less than S&P’s forecast of $2.55. S&P forecasts copper at $2.40 next year and Moody’s sees $2.35. The metal traded at $2.0795 on Friday.

If copper remains below $2.10 a pound, Glencore will lose its investment-grade rating based on forecasts for 2016, RBC Capital Markets analyst Tyler Broda predicted in a note Thursday. A junk rating would be “manageable” in the short-term and wouldn’t result in immediate challenges to the company’s funding, he said.

“There is a risk that if they fall below investment grade that some of those banks start to pare back liquidity,” Alon Olsha, an analyst at Macquarie Group Ltd., said last week from London. “It doesn’t shut the business down, but it does potentially reduce their capacity to take advantage of opportunities in the market. We are still quite along way off from that.”

‘Considerable Cash’

Glencore said in October that it’s taking actions to strengthen its balance sheet and plans to protect the credit rating. If the rating was lowered by one notch, there would be a “modest” increase in margin on its $6.8 billion, five-year revolving credit facility, according to a statement issued at the time. A spokesman for the company declined to comment for this story.

“Glencore’s marketing business continues to generate considerable cash flows,” Liam Fitzpatrick, an analyst at Credit Suisse Group AG in London who has an outperform rating on the stock, wrote in a Nov. 30 note to clients. “This, coupled with asset sales, should allow debt levels to fall over the next 12 months and insulate the balance sheet.”

Still, Glencore’s stock and bond prices reflect concern over how it can withstand its level of borrowing. The stock has plunged 71 percent this year, the most among companies in the U.K.’s FTSE 100 Index. It fell 3.3 percent to close at 87.29 pence in London on Friday.

Whilst Glencore has net debt of $30 billion its total debt figure was $50 billion at June 30 when including its commodity stocks, or ‘readily marketable inventories.’

Glencore’s debt is the most expensive to insure in an index of credit-default swaps on 125 investment-grade companies in Europe, according to data provider S&P Capital IQ. The contracts, which are also the worst performing in the benchmark this year, surged more than fivefold since January to 772 basis points. Anglo American Plc, the next riskiest, rose 380 percent to 763 basis points.

S&P’s negative outlook means there’s a risk it will review the credit rating if the macro environment is poor, according to Redmond. The company was given a negative outlook in September.

Lower commodity prices affect key credit metrics that S&P and Moody’s Investors Service use when assigning ratings, such as net debt to Ebitda. If commodity prices fall another 5 percent, Glencore needs to bring total debt reduction closer to $15 billion to preserve the rating, which is two levels above junk, according to Macquarie.

The renewed slide in metals is a blow to Glencore’s goal for a higher credit rating. The Swiss company believes that asset sales and other debt-reduction measures could lead S&P to upgrade its BBB rating by one notch in the long term, two people familiar with the situation said in October.

“Our negative outlook on Glencore’s Baa2 ratings assumes a prolonged difficult market that may cause a slower recovery in the financial profile, particularly if copper prices decline to below $2.20 a pound as they have in the past few days, and stayed there for a period of time,” Elena Nadtotchi, vice president, senior credit officer at Moody’s, said in an e-mail last week.

“The challenge for the company is to continue reducing its gross debt, while retaining sufficient liquidity and working capital funding in order not to constrain its earnings capability,” she said.

Peter Grauer, the chairman of Bloomberg LP, the parent of Bloomberg News, is a senior independent non-executive director at Glencore.

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