How Glencore shares could hit a record high

These shares have fallen sharply in recent days, but it could be an opportunity to buy this mining giant on the cheap, according to one expert.

A review of mining giants has favoured Glencore (LSE:GLEN) over Anglo American (LSE:AAL) as sentiment turns after two years of profits being underpinned by supply shocks and buoyant demand.

Against a new backdrop of higher interest rates and greater recession risk, Morgan Stanley has shifted its focus to cash generation and balance sheet strength.

Unlike in previous downturns, where the sector has tended to deliver a mixed performance relative to the wider market, it points out that financial gearing is significantly lower and that valuations appear more reasonable.

The US bank favours Glencore on the grounds of its spot free cash flow yield of 29% and potential for above-normal coal prices to drive significant capital returns.

It bolstered its target price on the FTSE 100-listed stock by 19% to 740p, a potential record and well ahead of a peak of 548p set earlier this month.

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Glencore shares have fallen back in recent days after the decline in copper price reached bear market territory, compared with the high seen in March. Copper generated 37% of Glencore’s earnings last year, fuelled by the transition metal’s role in decarbonisation efforts.

The company also operates about 26 coal mines across Australia, Colombia and South Africa, with some 85% of this production exported to countries where coal continues to play a leading role in power generation given its reliability and affordability.

A quarter of Glencore’s 2021 earnings were from coal, which until the Ukraine war had been valued on low multiples due to environmental and demand concerns.

Glencore’s other division trading commodities recently said the tight supply conditions had contributed to first half earnings being above the top end of its forecast range.

The company is due to present half-year results on 4 August, when analysts believe a further big return of capital to shareholders could be announced.

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In 2021, Glencore delivered about $2.8 billion of shareholder returns, which included a $500 million special cash distribution and $750 million of share purchases.

For this year it has recommended a $0.26 per share base distribution worth $3.4 billion and payable in two equal instalments. This comprises $1 billion from marketing cash flows and $2.4 billion of industrial cash flows.

Glencore today rose 9.5p to 458.5p after today’s Morgan Stanley note, a performance ahead of other heavyweight miners as the US bank cut Rio Tinto (LSE:RIO) to “equal-weight” after its analysts turned 'neutral' on iron ore due to weaker supply-demand dynamics.

It cut Rio price target to 6,230p, while acknowledging the appeal of its balance sheet in a potential downcycle and ability to sustain an attractive dividend yield. Revised commodity price forecasts mean the Anglo American target has reduced 3% to 3,400p.

Overall, Morgan Stanley believes the industry’s return on capital employed will decline from a cyclical high of 25% in 2021-22 to about 12% in 2024 as shareholders' share of revenues is offset by higher wages and government tax rises.

However, the impact of persistent inflation, logistics bottlenecks, supply constraints and shifting trade flows should support structurally higher commodity prices.