I met with demographics and commodity expert Paul Hodges this week (see my last interview with him here).
We talked about how the fall in Chinese growth has given us the collapse of the third great bubble in recent financial history – the commodity bubble (the first two were the dot com and the subprime bubbles). And we wondered when the stock market carnage of the last few months would start to translate into corporate carnage.
The answer, as it turns out, is about now. Commodity trading giant Glencore, the worst performer in the FTSE 100 so far this year (off around 50%) has announced that it has recognised that its debt burden is far too high for comfort and that it has to do something about it. That something is to cancel the dividend payout, to sell some assets and to ask investors to give it a new pile of cash to play with (there is to be a $2.5bn equity raising).
The chief executive, Ivan Gasenberg, reckons this will make the balance sheet so resilient that it will be “pitched… for Armageddon”. If only that were so (given that there is every possibility that in the context of commodity prices Armageddon may well be what Chinese slowdown gives him). It isn’t.
Right now, Glencore’s net debt (before interest, tax, depreciation and amortisation) is a whopping three times its earnings. That’s way too high. Stupidly high. The kind of high that could only ever have made sense if the management team had visited the future and confirmed that commodity prices would rise in a straight line for ever.
And even after depriving investors of their dividends and diluting their shares with a fund raising round, the firms net debt will, says James MacKintosh in the FT, be twice its earnings. That’s still way too high. Glencore will be on the danger list for some time to come.
Perhaps, rather than getting ready for Armageddon now, Gasenberg might have been better remembering that bad times always follow good, and that highly indebted companies always weather the bad times worse that those with more sensibly structured balance sheets. It is also worth pointing out that they have a high propensity to suffer in the good times too.
Even if commodity prices recover from here, Glencore will still have too much debt – and still be known to have too much debt, something that will make it hard for it to improve and/or restructure its business in future.
For a depressing case study on this, Glencore’s management need look no further than Thomas Cook. A recent Bloomberg story noted that the travel firm is finding it almost impossible to compete with its “less cash constrained rival TUI AG”. With its interest costs alone running at £130m year the 175 year-old firm just can’t “generate the cash needed to fulfil its modernising ambitions.”
The result is that, in the face of intense competition from no-frills airlines and online booking sites, and with TUI adding 60 exclusively owned hotels and resorts to its offering over the next five years, Thomas Cook can’t keep up. It is, Andrew McNally, author of Debtonator, tells me “a great example of how excessive debt kills a corporation long before the administrators are called in” – and a reminder to investors to steer clear of heavily indebted firms at all times, regardless of how clever their borrowing looks in the good times.