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Faisal Humayun
Faisal Humayun
Articles (598)  | Author's Website |

Is There More Upside for Freeport-McMoRan?

Improving balance sheet and firming commodity prices are positive signs

March 20, 2017 | About:

At the beginning of 2016, nothing seemed to be going right for Freeport-McMoRan Inc. (NYSE:FCX) as the stock plunged to $3.74 by Jan. 13, 2016. A year later, as overbearish sentiments peaked and positive developments within the company and industry came to fruition, Freeport-McMoRan witnessed a surge of 355% with the stock peaking at $17 on Jan. 24.

After a big 12-month rally, Freeport-McMoRan has subsequently seen profit booking with the stock lower by 25% from its 2017 peak. This decline presents an opportunity for long-term exposure. 

Status of PT Freeport Indonesia operations

On Feb. 20, Freeport-McMoRan issued a press release discussing an agreement with the Indonesian government. After five years of discussion, the renewed agreement requires PT Freeport Indonesia to terminate its contract and convert to a special license in order to export its concentrate production.

The new regulations, however, permit the continuation of copper concentrate exports for a five-year period through January 2022. Besides the special license, other conditions include a commitment to complete smelter construction in five years and paying export duties.

In order to be brief, the key point is the company can continue to operate under certain conditions. Its negotiations with the government, however, will continue.

Freeport-McMoRan’s operations in Indonesia provide significant employment opportunities in addition to the tax benefits for the Indonesian government. I do not see significant concerns in terms of continuity in operations. The key concern is the cost burden. To put things into perspective, Freeport-McMoRan has contributed $60 billion to Indonesia’s GDP since 1992.

Improving balance sheet

When Freeport-McMoRan stock slumped to $3.74 in early 2016, one of the factors contributing to the massive decline was failure to deleverage. In the last 12 months, however, the company has made good progress in deleveraging. It had net debt of $11.8 billion as of December 2016, down from net debt of $20 billion in December 2015.

The debt reduction was achieved through a mix of asset sales and new equity offerings. This provides the company increased financial flexibility and the capability to navigate the current slowdown. In addition to reducing net debt, Freeport-McMoRan also has an undrawn credit facility of $3.5 billion that adds to the overall liquidity buffer.

The company expects operating cash flow of $4.3 billion for 2017 (including $1 billion in working capital sources and other tax payments). Excluding working capital changes, operating cash flow of $3.3 billion would be sufficient to meet the capital expenditure target for 2017.

Therefore, I expect the company’s balance sheet metrics to remain healthy. The risk factor in this statement is Freeport-McMoRan can potentially suffer if the deal with Indonesia is delayed or does not meet the company's expectations. Higher natural resource prices can offset this negative. I am bullish on natural resources, and the Federal Reserve increasing rates is an indication inflation can potentially accelerate in the coming quarters.

From a debt refinancing perspective, Freeport-McMoRan has $1.2 billion in debt repayment for fiscal 2017 and $1.5 billion for fiscal 2018. This should not be a concern with total liquidity of $7.7 billion (including undrawn credit). Importantly, if copper and other natural resources trend higher, a change in operating cash flow can potentially ensure debt repayment is done through internal cash than debt refinancing or further equity issuance.

Conclusion

Freeport-McMoRan has surged from depressed levels and is still not overvalued after the big upside seen in the last 12 months. On the contrary, the recent correction of 25% is a buying opportunity for long-term investors.

The biggest risk at this point is negative impact on free cash flows due to restricted operations in Indonesia. Regardless, I believe the matter will be resolved since operations in Indonesia are not just beneficial for Freeport-McMoRan, but for the country as well.

Therefore, Freeport-McMoRan should be considered at current levels. In the coming quarters, I believe there is likely to be an inflationary environment, which will support the stock on the upside.

Disclosure: No positions in the stock.

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About the author:

Faisal Humayun
Faisal is a Senior Research Analyst with eight years of experience in equity research, credit research, economic research and financial modeling.

Visit Faisal Humayun's Website


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