There Goes The Rio Tinto “Exit Strategy”

Under pressure from investors, Glencore Plc (GLNCY), the world’s largest corporate player in the commodities market, recently announced a plan to slash as much as $10.2B in debt by offering additional shares to the market, selling assets, and eliminating dividends.In the first half of 2015, Glencore spent $1.8B on distributions and buybacks,

Glencore reassured investors that this plan will not impact core business activities.

I take three primary lessons or implications from this move by mighty Glencore:

Glencore’s capitulation to anxious investors implies that the odds of a continued collapse in commodity prices remains high. Note that the company DID use this opportunity to reiterate the supply challenges for copper and zinc. The company also thinks seaborne thermal coal has come into balance.

Commodity-related companies with poorer capital structures will likely be forced to make similar moves in due time, especially cuts of whatever dividends are still offered as carrots to keep investors interested.

Glencore’s appetite for acquisitions in this environment has likely greatly diminished. Major acquisitions, like a deal with Rio Tinto (RIO) should be completely off the table for the foreseeable future.

From point #1 and #2, I have slowed down my eagerness to shop for additional cheap commodity plays. Some commodity plays are likely still good shorts on rallies. Point #3 means that the upside risk (opportunity) for RIO has significantly come down. I no longer view my long-term call options on RIO as a hedge/lottery ticket on a potential deal with Glencore. There goes the Rio Tinto “exit strategy.”

Source: FreeStockCharts.com

In recent trade, Rio Tinto (RIO) has bounced around largely independent from the volatility in the price of iron ore (shown approximately as an overlay). While I still do not want to short RIO, shorts of BHP Billiton Limited (BHP) are quite sufficient for taking the bearish side of the iron ore trade. Like so many commodity-related stocks, BHP is firmly locked within a well-defined downtrend.