Glencore Xstrata (Price: 342p | Target: 307p | Rec: Sell)
Trading activities may provide peerless insight into commodity markets, but we worry whether the policy of maintaining an aggressively geared balance sheet is really appropriate following the merger with Xstrata.

With the industrial side of the business vulnerable if commodity markets underperform, we see Glencore Xstrata as exposed to greater refinancing risk than its peers.

With the valuation looking high, both against other mining majors and our NPV, we initiate with a target price of 307p and a Sell recommendation.
* Highly leveraged.

With FY14E Net Debt:EBITDA of c3.3x, we estimate an interest cost of US$1.8bn pa.

This could increase by as much as US$500m pa if interest rates rise by one percentage point.

The company has US$17bn of bond debt that comes due in the next few years, leaving it exposed to potential volatility in debt markets on refinancing. * Earnings now more correlated to commodity prices.

Following the merger, the company has evolved into more of industrial company than a trading house, but one with high gearing.

Consequently, negative commodity price shocks could see its credit rating come under pressure, prompting a need to deleverage the trading side rapidly to avoid a sharp increase in the cost of finance that would compound the impact on earnings. * Working capital intensity high.

The nature of the business ties up significantly greater working capital than other mining companies as a consequence of trading and an extensive and complex smelting and refining infrastructure for its metals and minerals division. * Too dear for us.

We value the company on NPV and (arguably generous) two year P/E and dividend multiples set at parity to the average of major UK listed mining peers.

This equates to a target price of 307p and we initiate with a Sell recommendation.
To access the full note please click here Analyst: Marc Elliott
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