The precious metals space is a very cyclical industry. Companies that mine for gold and silver are almost entirely reliant on the price of these metals. When prices are increasing, these businesses flourish and are able to use excess capital to pay dividends to shareholders.
When prices are declining, however, these businesses suffer. This means precious metals miners lack stable cash flow, which can make paying dividends difficult when commodity prices fall. Income investors looking for reliable dividends will likely avoid this sector for these reasons.
For investors with a higher tolerance for risk and a desire for income, there are stocks in this sector that could offer growth and dividends, along with the potential for high rates of total return.
Our favorite silver stock today is Glencore PLC (GLCNF, Financial).
Company background
Founded in 1974, Glencore is a worldwide leader in the mining sector. The current company was formed when Glencore completed its acquisition of Xstrata on May 2, 2013. The company has a market capitalization of $37 billion and produced more than $220 billion in sales last year. This makes it the largest commodities trading company in the world.
Glencore smelts, refines, mines, processes and stores silver along with a host of other metals, including copper, zinc, aluminum, nickel and iron ore. Glencore is truly a global company as it has operations on six continents.
The miner is headquartered in Switzerland and is also that nation’s largest company. While the company produces more silver than any other product, Glencore also has an energy and agricultural products segment. These segments have allowed the company to become much more diversified than most others in the mining sector. For example, Glencore is among the top three producers of copper, cobalt, zinc and seaborne energy coal in the world.
Recent financial results
Glencore reported first-half results on Aug. 8. Adjusted earnings before interest, taxes, depreciation and amortization declined 32% and adjusted Ebit dropped 56% as almost all of the company’s commodities saw lower pricing from the same period in 2018.
The primary reason for these declines was a 58% drop in cobalt prices. Excluding cobalt, adjusted Ebitda and adjusted Ebit were down just 6% and 12%. Silver production and average price per ounce both declined 7%. Also impacting the company’s performance was a 14% drop in coal prices and a 12% decline in silver prices. Oil was lower by 7%.
Adjusted Ebitda margins were 27% for the first half, but climbed to 39% when excluding the company's copper mines in Africa and its Koniambo nickel mine. The decline in margins is due to the ramp up and development costs of these mines.
One positive note, Glencore expects production to be above 2018’s level for several commodities, with much of the increase coming in the second half of the year. Zinc production should increase 12%. Coal production should grow 12.4%, while oil production should be higher by almost 20%. On the other hand, African copper production will likely decrease 8.8%, and the rest of Glencore’s copper mines will see a 1.7% drop in production.
Glencore is also working to improve its balance sheet. The company ended the first half of 2019 with a net debt to adjusted Ebitda ratio of 1.24, but is looking to lower this ratio to 1 within the next year. Currently, Glencore has a credit rating of Baa1 from Moody’s and BBB+ from S&P. Both ratings are stable.
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Since acquiring Xstrata, Glencore’s earnings per share have declined at a rate of 6.2% per year. We feel the company’s size, scale and diversification should lead to 3% annual growth through 2024.
Dividend analysis, valuation and expected total returns.
Dividend growth over the past several years has been sporadic at best:
- 2014 dividends per share: 11.7 cents
- 2015 dividends per share: 18 cents
- 2016 dividends per share: 0 cents
- 2017 dividends per share: 7 cents
- 2018 dividends per share: 20 cents
While dividends compounded by 11.3% from 2014 through 2018, growth has not occurred in a straight line. To illustrate this, investors should note the company did not pay a dividend in 2016.
Since 2011, Glencore has paid a dividend twice per year, normally distributed in equal amounts in May and September.
Dividends are expected to total 20 cents per share in 2019, the largest total this decade. Using the Aug. 28 closing price of $2.74, Glencore offers a dividend yield of 7.4%. This is one of the highest yields among all mining companies.
So far, Glencore has not issued earnings guidance for the year. Using the company’s 2018 total earnings per share of 24 cents and our expected 3% growth rate, we forecast Glencore will produce 25 cents in 2019.
This equates to a price-earnings ratio of 11 using the current share price. We feel a target price-earnings ratio of 20 is appropriate given Glencore’s declines in earnings per share since the merger. This estimate is also in line with other price-earnings ratios among companies in the silver mining sector. If shares were to trade with this price-earnings ratio by 2024, the valuation would add 12.7% to annual returns over this period of time.
Total returns for Glencore would consist of the following:
- 3% earnings per share growth.
- 7.4% dividend yield.
- 12.7% multiple expansion.
In total, we believe Glencore can offer investors an annual return of 23.1% over the next five years. This is well above our expected total annual return for the next stock listed on our top silver mining companies.
Final thoughts
Investing in the mining sector can be difficult to do as companies' fortunes are almost always directly tied to the price swings of precious metals. We find Glencore attractive because, in addition to its mining exposure, it also has an energy and agricultural products segment.
Glencore also has one of the lowest valuations and highest dividend yields in the mining sector. While we stress that only investors with a higher appetite for risk consider entering this space, Glencore’s potential for high total returns through 2024 earns the stock a buy recommendation from Sure Dividend.
Disclosure: No positions in any stocks mentioned.
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