Xstrata is the world's fifth-largest miner. Its earnings before interest, tax, depreciation and amortisation (EBITDA) come from extracting coal (43%), copper (33%), zinc (5%), nickel (8%) and alloys (11%). It owns a 24.9% stake in platinum producer Lonmin (worth around $850m), bought last summer. The big news for Xstrata came in February, with a controversial $5.9bn rights issue to cut its $16.3bn debt load. It also spent $2bn to buy the Prodeco thermal coal-field from its main shareholder Glencore.
Xstrata (LSE:XTA), tipped as a BUY by Deutsche Bank
Critics reckoned the deal smacked of providing a cheap loan for Glencore to take up its rights. But Xstrata still secured the much-needed funds. Sure, there are lingering concerns that it may have to return to the watering hole if the cash proves insufficient to avoid a breach in its banking covenants. Yet I suspect this outcome is remote because commodity prices are firming almost daily. Even if a fresh capital injection was needed, the board could potentially dispose of its Lonmin and/or Prodeca assets.
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More important is what's happening in the wider economy. After a period of collapsing demand after last year's sky-high prices, supply destruction is now centre stage. Global nickel production has dropped 20%, while output of zinc, coal and copper has dived 9%, 13% and 9% respectively. This could trigger a sharp snap-back in prices as the benefits from the $2trn or so of government stimulus packages begin to kick-in. A large proportion of this investment (eg, 70% for China) has been earmarked for metals-intensive infrastructure.
I would rate Xstrata on a through-cycle enterprise value (EV)/EBITDA of six. After deducting its proforma debt of $13bn, this generates an intrinsic worth of around 700p a share.
This is not a stock for the faint-hearted. The group is exposed to the very volatile metals and foreign-exchange markets and will probably not pay a dividend anytime soon. Plus there's always a chance that Glencore (34.5% stake) may become a distressed seller, triggering a large stock overhang. But with industry capacity being mothballed and commodity prices heading north, Xstrata looks a good long-term play on the industrialisation and urbanisation of emerging countries. The next trading statement is due on 5 May.
Recommendation: speculative BUY at £5.25
Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments
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