I must admit that when I last wrote about Freeport-McMoRan (NYSE: FCX) at the end of the last year, I did not envision that the situation will develop so fast and the stock will drop to astonishing levels. Yes, I was skeptical, but the market brutally punished the company for another leg down in copper and oil.
The price action in Freeport-McMoRan (and other commodity stocks) reminds me of the 2008-2009 crisis, when I was a day-trader for a prop trading firm and was shorting $2 stocks and making 40-60 cents on them intraday. In other words, this is plain panic and, possibly, forced liquidation by those who were unfortunate and played on the long side with margin.
Activism gone wrong?
My above-mentioned article was dedicated to the topic of selling Freeport-McMoRan's oil and gas assets via an auction process. Before the auction process came to Freeport-McMoRan's mind, the company was weighing multiple strategic alternatives, including a spin-off of the oil and gas business, an IPO of a minority stake in this business, joint ventures and capex cuts. Capex cuts were announced along with the elimination of the dividend.
The sale via an auction looked like a result of Carl Icahn's activism to many observers including your author. However, Freeport-McMoRan could turn into another case when an activist gets stuck in a commodity company as the negative environment prevails. The other case that first comes into my mind is the one of Cliffs Natural Resources (NYSE: CLF), where Casablanca Capital won a proxy war, appointed a CEO who was (in my view) doing the right things only to see Cliffs' shares trade below $1.50.
Too low to sell
The initial purchase of Plains Exploration and Production together with McMoRan Exploration created a massive debt burden for Freeport. Later, the company divested Eagle Ford assets for $3.1 billion of cash, but a significant amount of these proceeds were reinvested back in the deepwater Gulf of Mexico assets.
Also, don't forget that Freeport-McMoRan was investing - and investing heavily - in its oil and gas assets for 2.5 years that it owned them. In fact, according to the above-mentioned press release dedicated to this topic, Freeport-McMoRan is still expected to spend as much as $1.8 billion on its oil and gas segment in 2016.
The company's purchase of oil and gas assets was worth $19 billion at the time. Now the whole Freeport-McMoRan's capitalization is below $5 billion at the moment of writing. If oil and gas assets were sold today, the sale would have been a textbook example of fast value destruction. However, the sale will not happen, at least for now.
The debt problem
The most important thing to consider is how much debt could theoretically take Freeport's oil and gas segment as a separate entity. In 2015, the company estimated sales of 52.7 million boe (barrels of oil equivalent) at cash production costs of $19 boe. In 2016, the company expected to produce 59 million boe. Assuming that the average realized price per boe in 2016 is $30, the company's oil and gas segment will have $649 to spend on capex, G&A and interest payments.
Current oil and gas prices do not allow Freeport-McMoRan to offload any significant portion of debt to its oil and gas segment as it is clearly not ready to service any meaningful debt payments if prices stay low. Also, I don't see how the above-mentioned $1.8 billion of capex could be financed from cash flows from oil and gas operations if prices do not increase.
When the company reported third-quarter results, it was using Brent oil price of $56 per barrel as an assumption in its calculations. At that price, capex assumptions for 2016 look reasonable. However, at current prices, numbers just don't add up. Also, copper won't be able to subsidize the oil and gas segment much more.
My December prediction came true and copper slid below $2 per pound. In my view, it is the copper's dive below $2 that triggered panic selling in Freeport-McMoRan's shares in the last few days. Despite the fact that oil is firmly sitting in headlines, copper is much more important for Freeport-McMoRan's financials.
An additional downside of several dollars does not change the big picture for the company's oil and gas segment. On the contrary, each 10 cents of additional copper downside deliver a $330 million blow to the company's operating cash flow according to its own calculations.
All in all, I believe there are no strategic alternatives now for Freeport-McMoRan but to cut capex to the bone and wait for the oil price rebound. I can't imagine that someone will pay anything close to a decent price for Freeport-McMoRan's oil and gas assets. A fire sale won't solve the company's debt problem but will limit its upside possibilities when oil prices ultimately rebound.
What to expect from Freeport's shares?
I think that Freeport-McMoRan's shares will likely be a trader's paradise and an investor's nightmare until the company reports its fourth-quarter results and holds the earnings conference call. There are a lot of questions that should be answered by Freeport-McMoRan's management.
I don't think that Chinese news will evaporate from headlines any time soon, so you can expect significant volatility in copper which will translate into volatility in Freeport-McMoRan's shares.
I respect market sentiment and I don't catch falling knives. I must admit that I'm in a trading mode regarding commodity companies now, as I see similar patterns like in 2008-2009 when it paid off to trade volatility and then wait for survivors to emerge. The global commodity sell-off is becoming more irrational with each day, and, if history is any guide, irrationality could last longer than people expect (or stay solvent).
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I may trade FCX.