Last week, I wrote an article on Seadrill (SDRL) and whether the company can survive the bear hug. The article focused on the company’s balance sheet and credit metrics going forward. Freeport-McMoRan (FCX, Financial) is yet another name in the natural resources sector that has been beaten down significantly, and the decline has been accelerated by leverage concerns (similar to Seadrill). This article discusses the company’s balance sheet health and if the company can survive another 12 to 18 months of pain for the industry.
This is relevant because the Chinese markets have been underperforming recently. China equities have slumped and there are fears that the worst is still not over for the country. While I remain positive on China for the long-term, substantial economic weakness in the next 12 to 24 months can impact Freeport-McMoRan’s credit health. Further, Freeport-McMoRan is also suffering from continued decline in oil prices. The company’s offshore assets were expected to be EBITDA drivers, but the steep decline in oil has completely changed the outlook.
As I mentioned earlier, the company’s balance sheet is the biggest concern and the following points are worth noting:
- As of Sept. 30, 2015, Freeport-McMoRan had total debt of $20.7 billion with $338 million in available cash and equivalents. With industry conditions likely to remain weak for at least 12 to 18 months, debt servicing pressure will sustain.
- For the first nine months of 2015, the company reported operating cash flow of $2.6 billion and this translates into annualized cash flow of approximately $3.5 billion. The company’s free cash flow will remain negative for FY15 and increase in debt in challenging times is a concern.
- For 2016, Freeport-McMoRan plans to reduce capital spending in the oil and gas segment to $1.8 billion. The company also plans spending reduction in the metals and mining segment to $2 billion. This implies projected 2016 investment of $3.8 billion. I expect FY16 operating cash flow to be weaker than FY15 and the current investment plan implies further leveraging.
- Freeport-McMoRan was planning separate IPO or divestment of some assets (through JV agreements) in the oil and gas segment. However, with oil trading below $35 per barrel, an IPO is out of scene and divestment can only be distressed stake sale. Therefore, the liquidity concerns remain high and the result will be sharp decline in capital investment plan for 2016.
With these factors in consideration, the company’s credit metrics are likely to weaken through 2016. I expect Freeport-McMoRan to lower 2016 capital expenditure to be in line with the company’s operating cash flow. Even in that scenario, the company’s balance sheet debt will remain around $21 billion through 2016.
Amidst all these negatives, I see strong relation with bankers as a positive point for Freeport-McMoRan from a survival perspective. It was reported in September 2015 that Freeport-McMoRan has reached agreement with its bank group to amend the leverage ratio (net debt/EBITDA) under its $4 billion revolving credit facility and term loan from the previous limit of 4.75x to 5.5x at Dec. 31, 2015, 5.9x for the first half of 2016, and stepping down to 5x by year-end 2016 and 4.25x in 2017. With the market conditions worsening, I expect further amendments to the loan agreement in the next few months.
From an investment perspective, Freeport-McMoRan has slumped by 68% in the last six months, and this makes the stock look attractive at current levels. The recent market meltdown in China, however, implies that investors still need to remain cautious as the country is the biggest consumer of industrial commodities. Even with oil, there are downside triggers related to Iran commencing oil exports. Therefore, it would be best to stay in the sidelines and investors who are willing to take some risk can consider near-term trading exposure.
Disclosure: No positions in the stock.
