In the last year, Freeport-McMoRan (FCX, Financial) has slumped by 70%, and the decline in the stock has been due to decline in industrial commodity price as well as decline in oil and gas prices. While the overall outlook for industrial commodities remains bearish for the foreseeable future, I believe that Freeport-McMoRan has discounted the negatives and is currently trading at attractive valuations. The stock at current levels may benefit investors with a long-term investment horizon.
Debt of $21 billion is one of the major concerns for Freeport-McMoRan. The company recently announced that it may offer and sell shares of common stock having aggregate gross proceeds of up to $1 billion from time to time. This will dilute equity, but this is a positive step to reduce debt or make capital investments in FY16 using proceeds from the common stock offering. This will help Freeport-McMoRan maintain a sound balance sheet profile in FY16.
Freeport-McMoRan has also announced that it filed S-1 registration statement on June 23, 2015 for potential IPO of oil and gas subsidiary. This will be a positive step towards shareholder value creation and will unlock the real value of oil and gas assets. Further, the proceeds from the offering will provide Freeport-McMoRan with much-needed liquidity for investment. Therefore, the common stock offering potential and the potential for IPO are two positive upcoming factors.
Freeport-McMoRan was also relatively aggressive in terms of its capital expenditure plan for FY16. In a recent announcement, the company has decided to reduce FY16 capital spending from $5.6 billion to $4.0 billion. This is a positive development as a capital expenditure of $4.0 billion can be largely funded through internal cash flows.
Any further liquidity requirement can be fulfilled by common stock offering and existing cash. The point I want to make is that Freeport-McMoRan’s debt level will remain stable or decline in FY16, and this will be a positive development for a company with $21 billion in debt. I must mention here that Freeport-McMoRan does have access to $3.0 billion in undrawn credit facility, and this indicates that financers are confident of the company’s debt servicing capability.
Another point that is worth mentioning related to the company’s oil and gas asset is that, at an average realized price of $50.04 per barrel in 2Q15, the company reported $31.0 per barrel in cash operating margin. Therefore, the asset has potential to generate decent EBITDA even in a low oil price environment. When oil prices trend higher, the oil and gas segment can be a game changer.
To put things into perspective, even at $70 per barrel oil and 175mboe/d production, Freeport-McMoRan can generate $1.9 billion in EBITDA. Therefore, the company has quality long-term assets and investors need to hold the stock with patience for strong returns when commodity price recovers. For now, the company’s initiative to be conservative on investments and the common stock offering plan will ensure that credit metrics remain strong.
In terms of risk, oil prices have discounted the Iran supply factor and with production declining in the U.S., oil has probably bottomed out. Therefore, the oil and gas segment is likely to witness relatively better conditions in FY16. However, prolonged depression in industrial commodity prices is a risk factor and can impact the company’s cash flow from the copper segment. The reason to be bearish on industrial commodities is continued sluggish growth in China. Having said this, Freeport-McMoRan has largely discounted this factor, and the stock will trend lower only if growth further slides in China and other economies.
In conclusion, Freeport-McMoRan is a value investment, and some exposure to the stock is recommended for investors willing to hold it patiently for the next few years. The company’s recent initiatives ensure that there will be no balance sheet-related crisis, and Freeport-McMoRan will see through challenging times with sound fundamentals.
