Glencore Xstrata promises fiscal discipline

VANCOUVER — It was not always a smooth process and it took a year to gel, but Glencore International has completed its US$29-billion takeover of Xstrata, with the merged company trading as Glencore Xstrata (GLEN-L) and boasting a US$71-billion market capitalization.

Glencore Xstrata is now the fourth-largest miner by market cap after BHP Billiton (BHP-N, BLT-L), Anglo American (AAL-L) and Vale (VALE-N), with its production this year expected to tally 1.4 million tonnes copper, 120 million tonnes thermal coal and 1.4 million tonnes zinc.

On May 3 the company unveiled a new management team, which is to be run by hard-driving Glencore International CEO Ivan Glansberg and will feature a myriad of Glencore veterans.

“We believe there is large value that could be added to our group, having the traders sitting alongside the production base and deciding at what levels we should be producing, where materials should be stored and really getting the full benefit of that corporate structure that no other mining company has,” Glansberg commented during a conference call.

The company has already identified US$500 million in what it calls “cost-based synergies” on the trading side of its business, with US$450 million in savings stemming from “market optimization,” and another US$50 million coming from related transport and logistics benefits.

Glencore Xstrata’s lean capital strategy will likely be well-received in an industry that has weathered cost overruns and capital shortages, with the company pledging to eliminate unnecessary bureaucracy and administrative duplication.

“The departments are reviewing it constantly — and yes, we have identified other potential savings, and I think there are more — but we cannot quantify that yet,” Glansberg says. “A good way to look at it, however, is that Xstrata itself was comfortable in saying they could cut US$300 million in overhead. That gives you an idea of the low-hanging fruit, and when you get rid of these business units and corporate offices, you can see something in excess of that.”

The cuts will close Xstrata’s corporate headquarters in Switzerland and England, which will save on staffing costs and reduce management layers.

Glencore Xstrata is also undertaking asset reviews, with results expected during the third quarter. It’s likely that the combined company will shed assets as a way to preserve capital and sweeten returns for investors. Glansberg cites current market conditions and the need for a “defensive stance” when he talks about the company’s portfolio.

“Being major investors ourselves, we’re focused on those returns, and we have always said that we’re focused more on near-term growth from brownfield operations,” he said, adding that it was important to lower the risk on development assets, and that recent cost overruns with many greenfield development projects were detrimental to the industry.

“So following the merger we’ll continue that way, looking at any ‘easy’ greenfield projects or mergers and acquisitions activity of existing operations whereby we do not have the big capital blowout risks we’ve experienced in the industry over the last couple of years,” he said.

BMO Capital Markets analyst Tony Robson described Glencore Xstrata’s message as “the words that markets want to hear,” citing a commitment to simplify portfolios and return cash to shareholders as positive outlooks.

But Robson writes that Glencore Xstrata’s shares appear expensive, with the company needing to “deliver on its promises to maintain its high stock premium.”

Robson bumped his stock rating to “outperform” after the company’s post-merger conference call, and maintained his $4 target price.

Glencore Xstrata shares were up 5.8% after the conference call, and closed at £3.47 on May 7.