When you look at Freeport McMoRan's (NYSE:FCX) earnings over the past couple of years, it's easy to say that the company is suffering from being in the wrong place at the wrong time. But that isn't the whole picture, because a good portion of the pain has been self-inflicted.
In 2011, when commodity prices were reaching what we now know was a peak, Freeport earned roughly $4.80 a share. As commodity prices headed lower, earnings fell to $3.20 a share in 2012, $2.65 in 2013, and a loss of $1.26 last year. Through the first nine months of 2015 the company's loss was over $7.75 a share. Things are clearly going in the wrong direction here.
On one hand there's an easy explanation for this dismal showing -- the prices of the commodities Freeport sells have been falling. There's only so much the company can do about that on the revenue side of things, and the pain falls quickly to the bottom line. However, there's a tap-on effect. As the price of commodities fall, so does the value of the reserves Freeport controls.
So, for example, 2014's loss includes roughly $3.7 billion worth of impairment charges in the oil and gas space, driven by falling prices. It also contained $1.7 billion of goodwill impairments because the company overpaid for acquired assets when commodity prices were higher. But Freeport isn't the only company feeling this kind of pain. For example, Chevron Corp. (NYSE:CVX) saw its earnings decline roughly 90% year over year in the second quarter. Falling oil prices, then, are taking a big bite out of even some of the largest and strongest commodity players.
Shooting yourself in the foot
But here's the problem with that last bit of information. Freeport has historically been a copper and gold miner, not an oil company. Although copper and gold are in the dumps, too, the business that's pushing Freeport deep into the red is really oil. This pain was caused by the company's roughly $20 billion deal to buy Plains Exploration and McMoRan Exploration in 2013.
To be fair, it would be hard to expect Freeport to have predicted the timing of oil's price decline. However, you can't give the company a complete pass. It was a bad move questioned by industry watchers even at the time it was made. How bad? If you pull out one-time charges from the company's second-quarter loss, largely related to oil and gas, it made around $0.14 a share. Do the same for the third quarter and a loss of nearly $3.60 a share turns into a loss of "just" $0.15. So, stepping back, the oil and gas acquisition has been a lingering weight around Freeport's neck since the day it was added to the portfolio.
And things aren't likely to get better in the near term, for three reasons. First, the value of oil and gas reserves is based on an averaging of historical prices. Since oil prices were still declining at this point last year, there could be higher prices still hidden in the average currently being used. Don't be surprised if you see more writedowns in the fourth quarter.
Second, of all of the company's businesses, oil and gas is eating the most cash. Indeed, in the third quarter about half of Freeport's capital spending when toward oil projects. But oil revenues were just under $600 million compared to the company's total revenues of nearly $3.7 billion. Essentially, one of the company's smallest businesses is eating up lots of cash.
The third reason Freeport's earnings problems are likely to linger unless big changes are made is that the oil acquisitions saddled it with a huge debt load. Before the deal, debt was around $3.5 billion. After the deal, debt ballooned to over $20 billion. Debt went from an easy-to-handle 15% or so of the capital structure to more than 60% at the end of the third quarter. That's a heavy load to lift, and it isn't going to go away quickly.
As you read through the third-quarter earnings release, keep in mind where Freeport has been and what that could mean for the future. There are appropriate discussions going on within the company about what to do with the oil and gas business. But the "fix" may not be as good for you as you hope. (Do you really want to own Freeport's oil operations as a stand-alone company if it gets spun off?) And any fix could still leave Freeport in a weaker state than before the deal.
To sum it up, it certainly looks like Freeport's management made a big mistake with the oil purchase. The earnings numbers are just a symptom of that error. You'll want to keep a close eye on the strategic moves it makes from here, because recent history isn't exactly inspiring. But it takes a deeper dive than just the headline earnings numbers to see why.