Freeport-McMoRan (FCX, Financial) was trading at $3.74 on Jan. 13. The stock started surging from those levels and by Feb. 22 the stock was higher by 112% to $7.93. Subsequently, the diversified commodity major declined by 9.2% to current levels of $7.2.
Is the stock still worth buying after the big rally? What are the key factors that have translated into bullish momentum for the stock?
Freeport-McMoRan declined almost unabated from $23 to $3.74 per share. Therefore, the selling was overdone, and the rally was bounceback from oversold levels besides the fundamental factors.
Coming to the reasons for the rally, the company’s intention to sell assets and reduce debt is the single biggest fundamental factor that supported the rally. As of December 2015, the company had $20.4 billion in debt, and debt reduction is a priority considering that the slump in industrial commodities and oil prices can be longer than expected.
More importantly, debt reduction is a priority as the company’s covenants have minimal headroom. In December 2015, Freeport-McMoRan reached an agreement with its bank group to amend the leverage ratio 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 declining to 5.0x by year-end 2016 and 4.25x in 2017.
The decision to increase the metric to 5.9 for 1H16 and to reduce it to 5.0 by the end of 2016 took into consideration the potential sale of assets to reduce debt more than an increase in EBITDA in the current industry environment.
On Feb. 15 Freeport-McMoRan reported that it has entered into a definitive agreement to sell a 13% ownership interest in its Morenci unincorporated joint venture to Sumitomo Metal Mining (SMMYY, Financial) for $1 billion in cash. This is the first deal as a part of aggressive efforts to reduce debt, and more asset sales are likely in the next few months.
It was also reported in January that Freeport-McMoRan has submitted a divestment price to the Indonesian government for 10.64% stake sale in the Grasberg copper and gold complex for a consideration of $1.7 billion. If this deal works in favor of Freeport-McMoRan, the stock is likely to surge higher.
Besides developments on the asset sale front, Indonesia’s Energy and Mineral Resources Ministry issued recommendation for Freeport-McMoRan to resume exports shipments from Grasberg on Feb. 9. This is yet another positive development as issues with the Indonesian government have also resulted in depressed valuations for the stock.
From an investment perspective, Freeport-McMoRan expects capital expenditure of $3.4 billion. This capital expenditure has been kept in line with $3.4 billion in expected operating cash flow for the year. If commodity prices further weaken, Freeport-McMoRan to reduce investments to be in line with the OCF. In other words, I expect no increase in debt as a result of investing activities during the year.
Considering the company’s moderate capital expenditure plan, aggressive plans to sell assets and the renewal of exports license from Indonesia, Freeport-McMoRan is worth considering even after the big rally in the last one month. It is important to note that the rally came after a big selloff and a 100% upside does not necessarily imply that the stock is overbought.
However, considering the challenges faced by the industrial commodity and oil and gas industry, I still remain cautiously optimistic on Freeport-McMoRan. Any big exposure to the stock is not recommended at current levels. Investors should consider small exposure with a long-term investment horizon.
Disclosure: No positions in the stock.
