EQUITY RESEARCH GLENCORE - BUY

This document is a Marketing Communication

Research Report:
ADVISORY PORTFOLIO Report Date 31st May 2011 Analyst Ravi Lockyer MSc Llb Collins Sarri Statham Investments Ltd

Implications of Glencores IPO are mostly positive

Glencore has listed in London and Hong Kong making it easy for investment institutions to access. At US$60bn Glencore has entered the FTSE 100 via fast th track entry and the prestigious MSCI World Index on 19 May 2011. But owing to a unique structure that combines Congolese mines with trading platforms/dealing floors, investors and analysts are grappling with understanding Glencores core operations and strategic direction. The interims due in August 2011 will help understanding and improve transparency. On strategy, the IPO has provided an acquisition currency, and US$7.9bn of liquidity. The strategy choices broadly comprise a) Merger with Xstrata / grand alliance with Anglo-American b) Emerging market pipeline growth / extension of trading activities in underweight commodities via acquisition / market share growth c) Split of Glencore trading operations from mine owner / operator. Our view is a) and b) are not mutually exclusive whilst c) is possible but unlikely. The core strategy of increasing operational / commodity diversity by expanding Glencores global reach is likely to remain intact. Memories of 2008 are fresh and a big reason for the IPO is to provide excess capital. To recap, Glencore sold its Columbian Prodeco assets to Xstrata (to pay for its rights take up in XTA 2009 rights issue) and provide liquidity for trading operations. At one point the CDS market was concerned at Glencores liquidity. Glencore then repurchased Prodeco at a premium in 2010. Whilst messy, the message was clear that the trading business and mining assets required capital that privately owned Glencore might struggle to secure. The IPO diversifies Glencores capital sources efficiently. In its IPO Admission documents, Glencore states it intends to pay an interim dividend worth US$350m (approx US$0.0505 cents per share) in respect of the half year. The 2011 annual dividend is expected in the range of US$0.14 to US$0.15 per share costing circa $1bn (cover 3.8x 2010 earnings). The Glencore directors and employee ownership at 83.1% after admission is an unprecedented situation. Glencores employee ownership prior to IPO was 100% excluding the $2.2bn convertible bond issued in December 2009 (converts to around 5.9% of Glencore equity). The non-manager shareholders are locked up for 360 days, whilst the lock-ups for managers and directors range from 2-5 years. The free float will rise past 20% in 2011 post the 90 day lock-up for convertible bond holders (end August) the bulk of $2.5bn of convertible bonds should be converted ahead of the 2014 redemption. That the IPO brings cultural change to Glencore is an understatement. The quote will incentivise staff but bring challenges i.e. managing rooms full of multi-millionaires. An analogy has been drawn with Goldman Sachs IPO in 1999, which did not hurt Goldmans profitability, though the sums involved were lower. Then CEO, Hank Paulsons Goldman shares were worth $220m at IPO against Glasenburgs $9.6bn payout from Glencore. The exodus of key staff, whether in teams en mass or key individuals the executive drip feed, is a risk factor for Glencore, and if it occurs would be taken badly by investors.

Stock Rating: BUY

Target Price.........583p Share Price........528.7p Yr Hi / Low...530p/514p Shares o/s ....... 6.923bn Market Cap ...... 36.6bn Avg Daily Vol........5.9m Dividend Yield .....1.73% Fiscal Year... 31st Dec 11

Glencore is a leading commodities trader and marketer, mine owner/manager and industrial conglomerate

Key Risks to Price Target 1. Glencore investment activities involves asset ownership in countries with significant political risk. 2. Glencore cost of funds could rise sharply if it cannot maintain an investment grade rating. 3. Glencores trading business is heavily dependent on key personnel and reliant on the effective risk management of personnel. Please also note the risk warnings on the last page of this document.

The IPO lock-ups are well designed to help staff retention and make departures problematic. The possibility remains of a Mr Copper / Sumitomo Metals type problem as Glencore increases its dominance in illiquid metals niches encouraging staff to increase risk / desk / counterparty exposures. The increased publicity also makes Glencore more transparent and easier to sue. Glencore operates in unstable countries with reduced asset security and dubious business practices. Glencore will have to disclose the details of operations and manage problems under more public scrutiny. Glencore is unregulated from a US perspective like its peers, Noble, Trafigura, Louis Dreyfus & Cie and Vitol Group. The Dodd-Frank legislation will hit proprietary trading at US regulated firms but these restrictions do not apply to Glencore or its peers, a major opportunity over the next ten years. The listing gives Glencore an advantage over the peer group by providing an attractive acquisition currency. Trafigura has a similar business mix specialising in coal, shipping, storage, metals and petroleum (2010: US$79.2bn revenues, US$1.2bn industrial assets) and would make a good fit.

Prudent application of IPO funds could lift S&P rating

Glencore IPO funds will a) increase its stake in Kazzinc (from 50.7% to 93%) at a cost of $2.2bn; payable in October 2011 b) fully fund the expansion projects in respect of Kazzinc, Mopani, Prodeco and Cameroon petroleum E&P costing around $5bn from 2011-14 and c) reduce debt below the $10.26bn of credit facilities currently available in non-recourse debt. The board is likely to also fund expansion projects from internally generated funds over the next 2 years leaving flexible the use of the earmarked IPO funds less the Kazzinc outlay. Running down Glencores bank debt appears a key objective for the board offering the opportunity to reduce debt costs and improve the rating. Glencore is keen to reduce the portion of the Xstrata stake held as collateral against bank loans. At the end of 2010, Glencores net assets were US$19.6bn against total assets of $79.8bn with liquidity at US$4.22bn. Glencore relatively high debt / equity ratio at 3.07x and lack of transparency is thought to be the reason for its low rating. S&Ps current rating on Glencore is BBB- (outlook positive) whilst Moody rates Glencore Baa2 (outlook negative). A key challenge is improving the credit rating which in the case of S&P is the lowest investment grade rating. Given the credit implications of being one notch lower i.e. non-investment grade the IPO proceeds if applied towards debt will improve the prospect of S&P lifting the rating, a move that could translate to interest savings over FY12.

Development of industrial asset portfolio / Xstrata

Company Xstrata UC Rusal Kazzinc Century Al Minara Resources Katanga Chemoil Recylex Total Stake size 34.4% 8.8% 93% 44% 70.5% 74.4% 51.5% 32.3% Commodity Coal/ Copper Aluminium Zinc/ Gold Aluminum Nickel/ Cobalt Copper Chemicals Lead/ Plastics Country Australia Russia Kazakhstan USA/ Iceland Australia DRC Singapore France Mkt cap (US$) $23.3bn $2.6bn $3.2bn $0.64bn $0.58bn $2.6bn $0.22bn $0.05bn $33.19bn

Source: CSS Investments Ltd

Glencores listed $33bn portfolio, a composition of various stakes in major metal producers offer considerable flexibility to the group in terms of corporate development in the event Glencore decided to pursue a consolidating strategy i.e. buying out minority interests. The portfolio provides $300m in annual pre-tax income (around $204m from XTA) below the cost of funding the portfolio. Hence Glencores net funding cost and exposure increases needs to be funded by group internally generated capital, borrowing or portfolio disposals. With Xstrata, there is flexibility and a working relationship. A Glencore merger would give Xstrata CEO Mick Davis the means to make a second attempt at Anglo American as well as provide synergy benefits to Glencore worth over $300m in annual net income. Ahead of the IPO, the Glencore CEO said a deal with Xstrata was a post IPO event and to be decided by the post IPO board. The only downside to an XTA combination would be XTAs low exposure to developing economies. A friendly merger with Xstrata appears a highly likely outcome as there would be little point otherwise in owning a 34.4% stake. Such a merger approach, we estimate has a 50% chance in the next 12 months. Glencores ownership of mining assets both in production and in development is a major plank of the growth story for the industrial asset division. Broadly this comprises the development of key copper, coal, zinc and oil assets in the 2011 to 2015 period. Significant output growth is being forecast from the major mines and oil fields highlighted below, this translates into an EBIT contribution of $1.1bn to 2015 for the African copper assets and $240m EBIT gain for Prodecos coal operations. Asset / Output pa Katanga (Cu) Mopani (Cu) Mutanda (Cu) Prodeco (coal MT) E&P(oil) (b/d)(Alen / Aseng) Kazzinc (gold) 2010A 2011F 2012F 2013F 2014F 2015F

52k 197k

110k 236k 24k

150k 210k 81k 17.6m 50k

174k 242k 104k 19.9m 50k

246k 232k 103k 20.3m 74.7k

308k 242k 103k 20.7m 67.8k

10m -

15.6m -

347k

625k

760k

815k

800k

790k

Source; Glencore plc A: Actual / F: Forecast

Base metal sensitivity..... a short-term concern only

Data from Goldman Sachs (below) suggests that 2010 which saw significant price inflation (>30%) in agriculture, energy, grains, copper was the best possible backdrop for Glencores revenue line (+36.3% 2010). Pricing strength in 2010 was variously attributed to factors outside of Glencores control notably, the Federal Reserves QE2 programme and unprecedented speculative interest in commodity ETFs a feature of 2010 that has so far not been evident in 2011. The annualised growth norm over the last 35 years of 6.7% in the S&P Goldman Commodity Index suggests a base case Glencore revenue growth assumption in a normal year. This equates to revenue upside of $10bn / net income $260m before any account is taken of the Glencore project pipeline. However there has arguably not been a normal year since 2006 so this assumption might not be reliable. The Goldman data makes clear the impact on commodity indices of a 2008 type crisis. In a worst case scenario, Glencore revenues could decline 25%-30% or -$40bn / net income -

$1.05bn. This risk would need to be set against growth, maturing pipeline opportunities at Mopeni and Prodeco, which should drive revenue gains of region $10bn to 2015. Glencore risk management stated VaR (value at risk) of approx 0.4% (Q3 2010) shareholders equity suggests the group daily loss exposure is circa $78m has moved between 0.1%-0.4% since Q1 2008.

Glencore Marketing an outstanding track record

The Glencore marketing business (2010 revenues $134bn / EBIT $2.3bn) provide marketing, sourcing, hedging, logistics support in a) metals / minerals b) energy products and c) agricultural products. Typically Glencore enjoys long term commercial relationships with key industrial counterparties. It is able to use arbitrage strategies to exploit pricing discrepancies in physical commodity markets, many of which are permanently volatile and fragmented by offering logistical support, product related marketing and futures market pricing opportunities. Glencores marketing contacts are able to connect and act as intermediary between industrial suppliers with end consumer companies. Glencore data suggests opportunities in raising its market share. Glencores volumes are less than 50% of addressable market size whilst in key markets, such as crude oil, ferrochrome, metallurgical coal, Glencore is below 20%.
Commodity Units Glencore volumes marketed Addressable Market Size Total Market Size Glencore addressable market share Glencore total market share

Metals/ Minerals Zinc metal Zinc conc Copper Copper Con Lead Lead Con Alumina Aluminium Nickel Cobalt Ferrochrom Energy Oil Thermal Coal Met Coal Agriculture Products Grains Oil/ Oil seed

m MT m MT m MT m MT m MT m MT m MT m MT m MT k MT m MT m bbls/d m MT m MT

1.7 2.4 1.4 1.8 0.3 0.6 6.7 3.9 0.2 18 1.5 2.5 196 30

2.7 4.8 2.8 6.1 0.7 1.4 17.6 18.2 1.4 77 9.1 87.8 692 254

12.7 24.8 18.7 46.9 9.0 6.2 81.6 42.0 1.4 77 9.1 87.8 4,556 830

60% 50% 50% 30% 45% 45% 38% 22% 14% 23% 16% 3% 28% 12%

13% 10% 7% 4% 3% 10% 8% 9% 14% 23% 16% 3% 4% 4%

m MT m MT

19 8

224 178

1,986 644

9% 4%

1% 1%

Source: Glencore 14th April 2011 Addressable market represents the relevant market for consideration of Glencore market share based on the volumes which are accessible to a third party marketer, whilst total market represents global production.

Profit growth at Glencore marketing is top-line not margin driven hence the need to grow market share and possibly acquire other trading companies. Forecasts for this division are deal sensitive with expectations relatively low EBIT $2.3bn in 2010 is sustainable, with growth in the mid single digits as a stand-alone. Glencore marketing (2,700 employees, 2010 EBIT $2.3bn, current capital employed $15.3bn / short-term debt $12.9bn) had a return on capital of 15% in 2010 and return on equity (RoE) of 78% suggesting net income of around $1.87bn. The IPO will lift total capital and reduce debt, increasing equity and lowering RoE. Given inherent uncertainties to forecasting performance in any commodity trading model, we estimate marketing net income will remain in the range of $1.9bn-$2.5bn to 2015 this would assume single digit market share growth in key commodities, static commission rates and stable commodity prices.

Valuation / conclusion
Post IPO Glencore has drifted lower with a performance at odds with early reports of a 5 times IPO oversubscription. Some investors are concerned over Glencores complexity, its high degree of exposure to African assets and multiplicity of base metal risk exposures. At 528p the group is capitalised at 36.6bn/US$60bn but investors appear to be attributing a low valuation if we use a sum of the parts approach to Glencore. Broadly, our valuation suggests 583p share price using low assumptions for the development assets a key driver of valuation to 2015.
Method: SOTP Glencore listed portfolio Glencore development E&P assets Kazzinc Glencore marketing Cash Debt Total Per share valuation Source; CSS Investments Ltd industrial portfolio/ Assumption Market value 2015 EBITDA assume $3bn 4x Pre-discount $33.2bn $12bn Fair value $31.5bn $10bn

Agreed terms 12 x EBIT 2010 IPO proceeds Kazzinc 2010 debt $11.7bn net

$27.6bn $5.6bn -

$3.2bn $27.6bn $5.6bn $11.7bn $66.2bn $9.56 / 583p

CSS forecasts FY2009-FY2011

FY 31st December ($m) Revenue EBITDA EBIT Net Interest Expense PBT Tax Net Income EPS (cts) pro-forma DIV (cts) A: Actual / E: Estimate 2009A 106,364 3,929 3,307 587 3,058 238 2,724 39.3 2010A 144,978 6,201 5,290 897 4,241 234 3,799 54.9 2011E 185,000 9,500 8,500 1,250 7,250 810 6,440 93 15

Collins Sarri Statham Investments Ltd Rating System as at 28th September 2009: ANALYST RATING DEFINITIONS: BUY: A buy rating is applied to companies with established businesses that are profitable and where there is further profit growth expected. A buy recommendation means the analyst expects the share to appreciate by 20% or otherwise to reach the share price target on the note. HOLD: The companys valuation appears to reflect investor expectations in the short-term. Alternatively the company is awaiting key developments that will impact on the share price. Investors are advised to await the resolution of these key developments. SELL: The companys valuation appears too high having regard to material uncertainties, declining profit prospects or has sizeable funding requirements. A sell recommendation may also be applied where the board have failed in key objectives or appear to be frequently changing strategy. A sell recommendation means the analysts expects the shares to fall by up to 20% or to fall to the price target on the note or otherwise to underperform the FTSE All Share Index. LONG :- The stock/ security is expected to appreciate to the targets within the short term SHORT : The stock/security is expected to decline to expected targets within the short term NEUTRAL (NR) Collins, Sarri Statham does not maintain a view in either direction Key to Material Interests: Below are the six standard disclosures of Material Interests. Of these disclosures, the following are relevant to this research report: Glencore Relevant disclosures: 6 1. 2. 3. 4. 5. 6. The analyst has a personal holding of the securities issued by the company or of derivatives linked to the price of the companys securities. Collins Sarri Statham Investments Ltd or an affiliate owns more than 5% of the issued share capital of the company. Collins Sarri Statham Investments Ltd or an affiliate is party to an agreement with the company relating to the provision of broking services, or has been party to such an agreement within the last 12 months. Our broking services agreements include a provision that we prepare and publish research at such times as we consider appropriate. Collins Sarri Statham Investments Ltd or an affiliate has been a lead manager or co-lead manager of a publicly disclosed offer of securities for the company within the last 12 months. Collins Sarri Statham Investments Ltd is a market maker or liquidity provider in the securities issued by the company. Collins Sarri Statham Investments Ltd has clients who hold either shares or CFD positions in this security

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