Freeport-McMoRan (FCX, Financial) has provided robust stock returns of 80% for the year to date with the stock witnessing a big rally after bottoming out in January.
However, in the last four months, the stock has been largely sideways, and this period of consolidation is a good opportunity to accumulate Freeport-McMoRan with a medium to long-term investment horizon.
Coming to the factors, one of the key objectives for Freeport-McMoRan for fiscal year 2016 was to sell assets and reduce the company’s leverage. On that front, there has been significant progress with $4.0 billion in asset sale transaction announced for the year to date. This is likely to translate into reduced debt in the coming quarters.
Just to put things into perspective, Freeport-McMoRan had total debt of $19.3 billion as of June; considering the Tanke transaction, the company’s debt is likely to decline to $17.9 billion. Further, Freeport-McMoRan will have cash buffer of $1.7 billion once the Tanke transaction is completed, and this is sufficient to cover $1.5 billion in debt maturity coming in 2017. Therefore, debt is likely to decline in 2016 as well as 2017.
Another important point to note from a debt and credit perspective is that Freeport-McMoRan expects operating cash flow of $4.5 billion for fiscal year 2016 with the company’s target capital expenditure of $3.1 billion for the year. This will ensure that the company is free cash flow positive for the year.
Further, the company has narrowed 2017 investment target to $2.3 billion and I expect Freeport-McMoRan to remain free cash flow positive even in 2017. Debt can potentially decline through asset sale proceeds along with extra cash buffer from operating cash flows.
The next point to be bullish on Freeport-McMoRan is the renewed rally in oil, and I expect the rally to sustain on the back of a weak dollar coupled with expectations of supply-demand gap narrowing down in 2017. EIA expects average oil price of $52 per barrel in 2017 and Freeport-McMoRan estimates that at $55 per barrel oil, EBITDA from the segment will be $1.2 billion.
I expect the stock to trend higher if oil surges above $50 per barrel as it would increase the EBITDA and cash flow outlook meaningfully. I must mention here that Freeport-McMoRan restructured $1.1 billion in drilling contracts to operate within cash flows. However, if oil does trend meaningfully higher, the company has strong flexibility to ramp-up drilling and exploration activity.
In the copper segment, Freeport-McMoRan expects an increase in copper volumes with the successful start-up of Cerro Verde. While copper price trend still depends largely on China’s recovery, the industrial commodity has bottomed out and in the long term, copper does have supply constraints. This will ensure that fundamentals remain firm and every 10-cent increase in copper price is likely to impact EBITDA by $325 million. Therefore, if a 12- to 24-month horizon is considered, there are reasons to remain bullish on copper and incremental EBITDA from the copper segment.
Besides these factors, I am also of the opinion that Freeport-McMoRan can still pursue noncore asset sales to boost the balance sheet and that can trigger further stock upside in the coming quarters. Also, it is worth mentioning that the oil and gas segment can still be the game changer for Freeport-McMoRan in the next three to five years. As planned earlier by the company, I expect an IPO for the energy segment once industry conditions improve and that will deliver significant value unlocking.
I see the current phase of consolidation as a good buying opportunity. Even after the big upside this year, Freeport-McMoRan has lot of value to offer when considering from a medium to long-term perspective. In the medium term, balance sheet repair will continue to remain in focus and the company is doing well on that front.
Disclosure: No position in the stock.
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