Glencore PLCshuge cash call announced this week both shocked and pleased the market. On one hand, by announcing the debt reduction plan Glencore has been able to allay shareholder concerns about the companys weak balance sheet.
However, by moving to raise cash now, Glencore has piled the pressure on peersBHP Billiton (LSE: BLT) andRio Tinto (LSE: RIO) to do the same and bolster their balance sheets.
Heavy debt loads
Both BHP and Rio have been actively trying to reduce their debt piles during the past year or so. But with commodity prices trading at 13-year lows, these two companies are under more pressure than ever before to reduce balance sheet leverage.
According to City analysts, based on historic figures, Rios net debt to earnings before interest, tax, amortization and depreciation (EBITDA ) ratio is less than one. BHPs net debt to EBITDA ratio is slightly over one. At present, these numbersarent causefor concern. Its generally considered that a company is financially sound if its net debt to EBITDAratio is less than two.
Nevertheless, whats really worrying analysts is the fact that Glencores sudden decision to issue equity, after months of rebuffing calls to reduce its debt level, could imply that the trading house believes commodity prices are heading lower.
Clearly, if commodity prices fell even further, it would be a disaster for the whole industry.
Further declines
Some of the Citys most pessimistic analysts have suggested that commodity prices could fall another 30% from present levels. And while its unlikely that these dismal forecasts will berealised, it is always wise to prepare for the worst.
The analysts doom & gloom scenario is projecting that BHPs shares could fall to as low as 446p if commodity prices fell a further 30%. This dismal forecast is based on the fact that the companys oil operations are still burning through cash at an alarmingrate, and BHP is paying out the majority of its profits as dividends to investors.
The doom & gloom scenario for Rio suggests that the companys shares could fall a further 56% to 1,037p.
Plenty of unknowns
The doom & gloom forecasts above may seemoverly pessimistic, but its worth remembering how wrong even the most dismal City forecasts were this time last year.
For example, during May last year, even the most pessimistic City forecast was calling for the price of iron ore to drop only as low as $86 per ton. Most analysts believed that the price or iron ore would settle at around $90 per ton. But the price of iron oredropped to a low of $44 per ton during July.
And as commodity prices plunge to new lows, BHP and Rios earnings estimates have been consistently downgraded. Specifically, this time last year analysts were expecting BHP to report earnings per share of $2.81 for 2016 and $3.16 for 2017.
Current forecasts are significantly lower than thosepublished 12months ago. City analysts now expect BHP to reportearnings per share of $0.95 for 2016 and $1.32 for 2017, 66% and 59% lower the initial predictions.
Similarly, the City has reduced its full-year 2015/2016 earnings estimates for Rio by 55% and 58% respectively.
The point here is that the future is extremely uncertain for miners. As a result, it is almost impossible to produce an accurate valuation for the companies.
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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.