How does the old saying go? It’s always darkest just before dawn? If that’s true of stocks (and it often is), then owners of Freeport-McMoRan Inc (FCX) may have wanted to hold onto their shares last month when it looked like they were headed into yet another free fall.
FCX is up more than 90% from its lowest close of January, and there’s been more buying volume behind the current rally than we’ve seen in months.
But, the U.S. dollar is still too strong, commodity prices are still too weak, so is demand for copper and oil still too tepid to put Freeport-McMoRan back in business, so to speak? Maybe.
But, knowing that all things are cyclical, investors at least have to entertain the possibility that the worst for Freeport-McMoRan may really be in the past.
That Was Then…
A month ago, things looked pretty grim for copper miner and oil driller Freeport-McMoRan. Jefferies had just downgraded FCX from a buy to a hold, economic malaise in China further threatened the company’s business, and the company’s co-founder — James Moffett — was strongly encouraged to retire. Oh yeah … commodity prices remained in a slump at the time, too, with no end in sight.
Then again, this was nothing new. It’s a song investors had been hearing since the latter part of 2014, when FCX would begin what ultimately became a near-90% rout.
The proverbial nail in the coffin, however, was arguably its debt woes.
Like so many other oil and gas (and minerals) names, Freeport-McMoRan was leveraged to the hilt with debt taken on at a point when copper and oil prices — the core pieces of Freeport’s portfolio — were healthy enough to allow the company to service these debts. Now they’re not.
This reality forced both Moody’s and Standard & Poor’s to downgrade the company’s credit rating to so-called “junk” status. Aside from crimping the value of its existing bonds, a weak credit rating makes it all but impossible for company to borrow at affordable rates. Forced to borrow on terms that are more expensive than its existing debts just to service those existing debts creates the proverbial death spiral.
Or, maybe there’s a light at the end of the tunnel after all.
…This Is Now
It’s admittedly an ugly solution, but Freeport-McMoRan may be able to dig its way out its hole after all.
The party started on Friday, when OPEC started to (finally) dance with the idea of cutting oil production to buoy prices. It matters because Freeport estimates it will sell 57.6 million barrels of oil (equivalent) in 2016. At the current price near $31 per barrel, that translates into approximately $1.8 billion worth of crude. That’s enough for a slight EBITDA, but for every $10 worth of higher crude prices, EBITDA rises by about $400 million per year. If oil has already hit its ultimate bottom …
The bullish flames were fanned further on Tuesday following the company’s announcement that it would raise $1 billion by selling part of its interest in its Morenci (Arizona) mine to Japanese company Sumitomo. Freeport-McMoRan will use the proceeds of the sale to pay off part of a bank loan.
The sale to Sumitomo won’t even come close to satisfying Freeport’s $20 billion or so in long-term debt. It’s an encouraging step in the right direction, though, validating CEO Richard Adkerson’s recent pledge:
“As we enter 2016, our clear and immediate objective is to restore FCX’s balance sheet and position the Company appropriately to enhance shareholder value in the current market environment. We are responding swiftly and decisively to achieve this objective. Our high-quality asset base provides opportunities for significant debt reduction while retaining a substantial business with attractive low-cost, long-lived reserves and resources that will enable our shareholders to benefit from improved conditions in the future.”
As was noted, if this is the shape of things to come — asset sales to facilitate survival — then it’s apt to be ugly. It’s better to face the tough choice on your own terms, though, than it is to resist the obvious solution and end up paying the price on the market’s terms.
Said in simpler terms, it’s better for Freeport-McMoRan to be proactive than reactive.
Bottom Line for FCX
It’s still an amazingly speculative play. But, the potential reward merits the risk. Oil prices may be en route to a true rebound… finally. Copper prices aren’t far behind, either. Both will be boosted by what looks like a U.S. dollar starting to struggle. It could be just enough to turn the tide in favor of FCX, even if just marginally. Meanwhile, Adkerson seems to be serious about doing for Freeport what the commodity market’s dynamics can’t do for the company. It’ll hurt, but it’ll work.
If nothing else, it’s a “buy when there’s blood in the streets” opportunity.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.
EDITOR’S NOTE: Corrected to mention $20 billion in debt, not $30 billion in debt. We apologize for the error.
