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Freeport-McMoRan Inc - Light at the end of the tunnel

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March 14, 2016 – Comments (0) | RELATED TICKERS: FCX

The quality of Freeport’s assets throughout the whole commodity downturn has never really been in question. Their timing of acquisitions and diversification into oil & gas has. Balance sheet strength, or lack of, at a time of falling commodity prices, combined with political risk attached to key assets, have created a perfect storm for management to struggle with all whilst against a negative sector backdrop.

However while management can improve, underlying assets cannot (and don’t need to in Freeport’s case)

Freeport, while struggling under a large pile of debt (net debt is above $20bn), partly brought on by its ill-timed acquisition of Oil & Gas assets, has shown via its sale of a further 10% in its Arizona based Morenci copper mine to Sumitomo Metal Mining, that the one thing it isn't short of is desirable tier one assets.

In an attempt to bridge the gap between cash flow brought about by plummeting commodity prices across the board and debt repayments, it has slashed capex at its copper and Oil & Gas divisions and is now divesting non-core stakes (this allows them to slowly restore the balance sheet and allows management to focus on core operations).

Management has implied that it plans to spin off its oil & gas assets which are actually long life, low cost, deep-water Gulf of Mexico assets with plenty of growth potential from its existing infrastructure (Holstein, Marlin and Horn Mountain deep-water production platforms have a processing capacity of 250MM bbl/day of oil which is not fully utilised)  which should gain interest from oil majors keen to add growth assets for the longer term.

At $35 oil Freeport would cover 2016 cap-ex and they estimate that productions costs will decline to $15 in 2016/2017e – so not a basket case by any stretch of the imagination.  

In regards to its core copper assets, copper is actually expected to be in balance in the medium term,  as ore grades decline  while large mines mature ( strip ratios rise ), plus a lack of investment in new mines brings the market back into balance.

Freeport’s copper assets centre around 4 jewels: the ultra-low-cost Grasberg mine in Indonesia where costs after by-product credits (one of the world largest gold mines also) are expected to plummet to $0.17 per lb; the long life US Morenci mine; Cerro Verde in Peru which after its expansion will host the largest concentrator in the world; and finally Tenke Fungurume in the DR Congo  which is one of the world’s largest high grade mines and should provide FCX with future growth.

Freeport also owns significant stakes in high quality mines such as El Abra in South America and various US mines  in which it could sell stakes or completely to alleviate debt levels if required, and recent per mt sale prices at Morenci were above that which had been expected, highlighting that there are still buyers of quality assets out there.

In respect of group debt levels going forward, the method and price it gets for its oil assets (they may be trying to ride out the storm to keep a hold of these assets) will determine the future level of debt that a new core Freeport has and thus what assets it may need to sell.

Freeport over the next 2 years fortunately has a relatively low level of debt maturing, which may give it the operational breathing room it needs to right itself. 

Cowen & Co think that Freeports debt levels will drop to around 3.2x by 2017 . However,   we suspect a level below 3x would be better received by the markets and asset sales are needed in order to achieve this. Freeport have offered to sell a 10.64% stake in its prized Grasberg mine back to the Indonesian government this year for $1.7bn ( for an implied mine valuation of $16.2Bn). A decision on which will be made shortly, but this most likely will represent the starting point of negotiations,   not a take it or leave it offer.

Freeport may decide to divest another portion of its remaining stake in the mine if it feels it can achieve a price above $17,500/mt.  One potential buyer of the stake is Rio Tinto who recently dropped its progressive dividend policy which would give it further financial fire-power if a bidding war for this stake occurred ( they would also be a natural buyer given Rio Tinto has a joint venture with FCX for a 40 per cent share of production above specific levels until 2021, and 40 per cent of all production after 2021 )

Just   weeks ago the situation looked potentially terminal for Freeport. However,   the recent stake sale may provide a glimmer of hope to investors. Freeport control assets in copper,   oil and gas which are undoubtedly world class ;   they just need to ensure they have the short/medium term financial strength to prevent a fire sale at below market rates.

Presently Freeport is limping on and may actually be an investable proposition once again, especially for those who believe further asset sales will be forthcoming and those   who   can see the long term upside of tier one copper assets. However after a near 70% up-tick since January lows waiting for the share price to exhibit some support may be prudent.

On first impressions, the outlook may seem bleak for Freeport - high debt levels, imprudent acquisitions, falling commodity prices and political risk attached to key assets create a seemingly unconquerable proposition for management. However, a wealth of desirable tier one assets and recent minority stake sales imply that there may be a way for management to hold onto key assets and reduce debt levels considerably over the next few years.

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