Morgan Stanley (NYSE: MS ) in a note dated Tuesday has upgraded Glencore (LON: GLEN ) to an "overweight" rating, citing exaggerated market concerns over coal prices and marketing profits, and flagging the stock’s discount to its sum-of-the-parts valuation.
The brokerage also named Glencore its new ‘top pick,’ arguing that the risk-reward profile is compelling and that the current market pullback is overdone.
Glencore’s shares have lagged behind other diversified mining companies as well as its own commodities basket, partly due to concerns about the impact of a potential resolution to the war in Ukraine on its earnings.
According to Morgan Stanley analysts, the stock has shown a -57% correlation with the MS Ukraine Basket, illustrating investor worries about the effect of lower commodity price volatility on the company’s marketing business.
Additionally, declining coal prices have further weighed on sentiment. However, Morgan Stanley contends that these concerns are overstated, emphasizing Glencore’s ability to manage downturns effectively and pointing to the steep discount to its SotP valuation as a sign of mispricing.
One of the primary concerns weighing on Glencore’s stock has been the possibility of a prolonged slump in coal prices.
While Morgan Stanley’s base case projects a recovery of 16% in Newcastle 6,000kcal and 13% in metallurgical coal prices by the fourth quarter of 2025, the brokerage acknowledges that some market participants fear a more extended downturn.
Despite these concerns, analysts believe Glencore is well-equipped to handle price volatility, citing the company’s history of proactive supply management.
During past downturns, such as in zinc, Glencore demonstrated its willingness to cut production and reduce spending to protect cash flows. Analysts believe the company would take similar action if coal prices were to decline further, mitigating potential downside risk.
Another key issue investors have raised is the potential decline in Glencore’s marketing profits if geopolitical tensions ease and commodity price volatility decreases.
Historically, the company has seen higher levels of profitability during periods of heightened volatility and supply disruptions. Some believe that an end to the war in Ukraine could dampen these factors, thereby reducing earnings from its marketing segment.
However, Morgan Stanley analysts argue that volatility remains elevated in the energy sector, and increased trade tensions have heightened geographic dislocations across base metals, particularly in copper and aluminum.
This creates new arbitrage opportunities for Glencore, suggesting that the marketing business can continue to perform well within its long-term EBIT range of $2.2 billion to $3.2 billion.
From a valuation perspective, Morgan Stanley sees significant upside potential for Glencore shares. Analysts highlight that at current market prices, the company’s enterprise value is effectively only accounting for its marketing and copper businesses, assigning no value to the rest of its operations.
This suggests that coal, zinc, nickel, and other segments are being discounted to zero in the market’s valuation.
Based on their analysis, applying various market multiples to Glencore’s copper business and other key assets implies an equity value in the range of 480 to 600 GBp per share, representing over 50% upside from current levels.
With Glencore's upcoming financial results on February 19, Morgan Stanley believes investor expectations have already been adjusted to reflect recent headwinds.
The brokerage notes that consensus EBITDA estimates for 2025 have been downgraded by 14% on spot prices, a revision they view as well understood by the market.
Analysts anticipate that Glencore will announce approximately $3 billion in capital returns for the second half of 2024, which aligns with broader expectations.
At current valuations, Glencore trades at a 2025 EV/EBITDA multiple of 6.3x, below its historical average of 7.9x, and is offering a free cash flow yield of 5-6% at spot prices.
With these factors in mind, Morgan Stanley believes the stock is undervalued, making its risk-reward profile particularly attractive.
The commodity company was trading 1.4% higher at 06:18 ET (11:18 GMT).