With Freeport-McMoRan (FCX 0.68%) having settled its spat with Indonesia over shipping unprocessed ore out of the country, the idea that the miner might give up even more of the gains made in the run-up to the announcement of that resolution stands at odds with the better performance many are expecting.
Is the hole too deep for Freeport to dig its way out of? Image: Grasberg mine, Indonesia. Freeport-McMoRan.
But every silver lining has its cloud, and several threats remain to Freeport's continued advance. The following are three of the most imminent.
China's economy continues to sputter
Gone is the heyday of double-digit annual advances in China's GDP. Although the 7% growth forecast still outdoes GDP growth rates of other others, it's clear China is faltering once more.
The HSBC Flash China Manufacturing Purchasing Managers' Index fell to 50.3 in August, a three-month low that missed Reuters' forecast of 51.5. While that reading remains above the 50-point line separating growth from contraction, it also indicates that industrial demand will be subdued -- an important consideration for copper, which has broad industrial uses, as opposed to gold -- and investment activity growth will be limited.
Electrical and construction comprise two-thirds of world demand for copper, and with home sales in China plunging 18% last month -- now down over 10% for the year -- any further slowing of China's economic engine will have a significant impact on that demand.
China will continue exerting undue influence over copper demand. Photo: Freeport-McMoRan.
Freeport derives almost 70% of its revenue from production of the red metal, and though China only represented 5% of company revenue in 2013, up from 3% the year before, the country will still have a significant say in the miner's performance, even if not directly.
As China consumes approximately 45% of the world's copper, it will determine the level of investment, lending, and output that occurs.
Copper pricing will remain volatile and may have peaked
In 2013, copper prices ranged from a low of $3.01 per pound to a high of $3.74, for an average of $3.31 per pound. Last quarter, it averaged $3.08 per pound and hit a four-year low in March. This past Friday, it closed at $3.19 per pound. Copper is nothing if not volatile, and likely will continue to be so.
The collapse of Chinese economic support described above may send copper prices in the same direction as iron ore, which has lost a third of its price value this year due to slow-growth signals from the country.
Some of the same factors could influence it, too. Earlier this summer, scandal erupted after one Chinese trading house was found to be illegally pledging the metal as collateral to more than one lender, which allowed the trading house to keep import levels above what a sagging economy ought to have dictated.
Freeport just sold one of its best copper concentrate-producing mines, Candelaria, in a bid to lower its debt and finance capital expnediture plans. Photo: Freeport-McMoRan.
Now, London Metal Exchange copper inventories are down to seven-year lows and Shanghai Futures Exchange inventories have dropped to their lowest level in over two years. Analysts see the situation worsening and find little reason to believe copper prices will rise.
The downside risk to pricing remains substantial, influencing Freeport's future capital expenditures, budgeting, and exploration, as well as leading the miner to shed assets.
Freeport has a heavy debt load
At $17.5 billion at the end of the second quarter, Freeport's long-term debt remains high, having gone off kilter after it purchased Plains Exploration & Production and McMoRan Exploration in 2012 for $9 billion. Although the diversification away from mining helps smooth out some risk, servicing the debt becomes a challenge and bringing it down to more manageable levels becomes imperative.
Freeport has already sold off assets such as its Eagle Ford shale oil and gas properties, and last month sold the Candelaria copper mine in Chile for $2 billion to Lundin Mining. It followed that up by announcing it was also looking to sell as much as $5 billion worth of other onshore oil and gas assets.
The horns of a dilemma: Freeport needs to sell assets to pay down debt and fund development of offshore oil and gas opportunities. Image: Horn Mountain gas field. Freeport-McMoRan.
In short, the company larded its balance sheet with too much debt in an effort to grow all at once, and now its operations have become too expansive and costly. At the end of last quarter, Freeport's debt-to-equity ratio stood at 0.82, a relatively high figure when compared to Newmont Mining at 0.65 and Southern Copper at 0.67. Even if Freeport meets its goal of reducing its debt load to $12 billion by 2016, its debt-to-equity level will remain elevated.
With cash on hand dropping to just $1.46 billion at the end of the second quarter, its quick ratio, which measures the ability to meet short-term obligations with its most liquid assets, stood at 0.56, meaning it had just $0.56 on hand for every $1 of debt.
Shedding otherwise valuable assets will only slightly improve those numbers, because the proceeds will also be used to finance the kinds of offshore exploration Freeport wants to focus on. Any further weakness in copper or gold prices will exacerbate its financial situation.
The takeaway on Freeport-McMoRan's stock
There's no doubt that Freeport-McMoRan is a better, more diverse company today than it was just a few years ago.
It remains positioned to capitalize on global opportunities that are still present as international economies dig themselves out of the morass of the financial crisis. Even China, with the risks it holds, offers an opportunity for growth.
But there is risk in jettisoning the ballast of a bloated balance sheet, even if the company must do so to better focus its energies on its most productive businesses. Investors would be wise to keep an eye on these developments.
