Is Freeport-McMoRan in Deep Trouble?FCX) announced its second quarter 2016 results on 26th July. The company reported a net loss of $ 479 million or $ 0.38 per share attributable to common shares compared to a net loss of $ 1.85 billion or $ 1.78 per share incurred for second-quarter 2015. Most of those reported losses were due to impairment charges related to oil and gas properties and drillship settlements/idle rig costs.
The company sold 1.1 billion pounds of copper, 156 thousand ounces of gold, 19 million pounds of molybdenum, and 12.4 million barrels of oil equivalents (MMBOE) during the second quarter of this year compared with 964 million pounds of copper, 352 thousand ounces of gold, 23 million pounds of molybdenum, and 13.1 MMBOE in the second-quarter of last year.
The average realised price for copper was $ 2.18 per pound while that for gold was $ 1292 per ounce.
And the company sold its oil for $ 41.10 per barrel on an average. This does not compare well with the year ago average realized prices of copper and oil which were $ 2.71 per pound and $ 68 per barrel respectively. However, the company substantially improved its gold margins from last year when it realized only $ 1174 per ounce of gold.
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Margin improvement also came due to the on-going cost reduction measures. The average unit net cash costs for mining operations dropped from last year’s $ 1.50 per pound of copper to $ 1.33 per pound of copper last quarter. Effectively, the site production & delivery unit costs for copper came down 23 % as shown in the adjoining snap of the conference call presentation. This reduction was primarily due to higher copper volumes and economies of scale which the company had been already expecting to come in. For oil and gas operations, the average unit net cash costs were $ 15.00 per barrel of oil equivalent, down from $ 19 per barrel. That meant an improvement of 21 % in the oil & gas cash production cost.
For the full year, the company expects these costs to average $ 1.06 per pound of copper for mining operations (including Tenke) while for oil and gas operations, $ 15.50 per BOE is expected.
Also, the above figure shows that over the next 10 years, existing mines' production is expected to decline by about 4 million tons that’s roughly 20 %. And it takes a long time to develop new mines and start supplying. So, in the long term we are going to see a copper deficit in the market and thus the incentive price of $ 3.30 per pound predicted by Wood Mackenzie looks reasonable.
Cash, debt, CAPEX:
Freeport-McMoRan generated $874 million of cash from operations during the quarter. This includes $278 million in working capital sources and changes in other tax payments. This operating cash flow exceeded capital expenditures that totalled $833 million. At the end of the quarter, the company had approximately $350 million of consolidated cash on the balance sheet.
However, Freeport-McMoRan balance sheet can’t be called to be a strong one. Although it didn’t borrow anything and also didn’t touch its $3.5 billion revolving credit facility during the second quarter, it still has a consolidated debt of $19.3 billion. Thus, going by balance sheet strength, Freeport-McMoRan is not investment grade.
To the relief of those already invested in Freeport-McMoRan, the company said in its conference call that it is targeting a debt reduction from around $19 billion at the moment down to $10.5 billion in the best case scenario if copper price averages $2.50 per pound through the end of 2017.
Even before this, the company has announced its plans of aggressive debt reduction especially by using the proceeds of asset sales of the order of $ 5 billion to $ 10 billion.
Freeport-McMoRan is focusing most of its energy on its mining business and getting rid of those oil & gas assets which had uncertainties regarding their future. It has entered into agreements for terminating three of its drilling contracts during the second quarter. This will save approximately $350 million, compared to the previously contracted commitments.
In addition to that, it will be raising over $4 billion soon as a result of selling 9% of its copper reserves too. Then, there is the Tenke asset sale which is expected to generate around $2.8 billion cash.
Thus, the company is likely to achieve that debt reduction target that it has set for itself provided it gets the support of favorable copper price as expected.
Freeport-McMoRan has again reported a loss and a 15% year on year decline in revenues. But these are highly correlated to commodity prices, especially copper. Commodity prices are purely an external factor. However, the company has been able to improve its costs and generate positive free cash flow in the second quarter. Plus, it has also shed a significant amount of debt of late and has intentions of almost halving its debt load clear. The long term prospects of copper market are also looking bright.
Therefore, we expect a huge upside in Freeport’s valuation going forward and find it worth investing for the long term.
Published on Sep 7, 2016By Yaggyaseni Mittra