Despite a challenging 2015, I had maintained a bullish stance on Freeport-McMoRan (NYSE:FCX) last year mainly because I believed that the measures taken by the company to adjust to the weak price environment would create shareholder value in the long-term. The sharp pullback in commodities, especially oil, since the start of this year though has had a significant impact on FCX's valuation. Unless FCX is successful in divesting its oil & gas assets, the stock price will remain depressed.
Late last year, there were reports that FCX was considering divesting its oil & gas unit. Reuters had reported that FCX could launch an auction for the oil & gas division. I had assumed that the company will be able to complete the auction in the first half of 2016 and the sale would have a significant impact on FCX's fair value. That has changed.
2016 could not have begun on a worst note for oil markets. Prices have dropped below $30 a barrel, a level not seen even at the peak of the financial crisis of 2008. I am therefore changing my key assumptions for valuing FCX. The main assumption I had made in previous note on FCX was that the company will be able to exit the oil & gas business in the first half of 2016. That looks highly unlikely now, given the state of the oil market. More importantly, it is the outlook for the oil market that is the big concern. The International Energy Agency (IEA) expects demand to outpace supply by around 1 million barrels per day in 2016. This will be the third consecutive year when demand outpaces supply by that margin, according to a report by the Financial Times.
I am now assuming that prices will remain at $30 per barrel for an extended period. For 2016, FCX had estimated that its operating cash flow would total $5.8 billion. Operating cash flow for 2017 was also estimated at $5.8 billion. The estimates were based on the following assumptions; average copper prices of $2.25 per pound, average gold prices of $1200 an ounce and average oil price of $56 per barrel. In the present scenario, those assumptions look extremely bullish. According to Freeport-McMoRan, its operating cash flow would reduce by $330 million if copper prices drop by $0.10 per pound. While I am more bullish on the prospects of the copper market, I expect prices to average around $2.10 per pound in the best case scenario. However, I have taken the worst case scenario of prices averaging $1.90 per pound. This means that FCX's operating cash flow would reduce by $990 million in 2016 as well as in 2017.
Gold prices have gained some strength as the turmoil in the global markets has boosted the precious metal's safe-haven appeal. However, prices are still almost $100 per ounce below FCX's assumptions. Assuming prices average $1100 per ounce in 2016 and 2017, this will further reduce FCX's by $130 million in 2016 and 2017.
Finally, oil is the big worry for FCX and perhaps the reason why the company finds itself in the position it is in right now. Indeed, when you compare FCX's performance to other major miners, it is clear that the company's oil business has destroyed much of the shareholder value. Since the start of this year, all major miners have been crushed but FCX's performance has been far worse. While the likes of Rio Tinto (NYSE: RIO) and BHP Billiton (NYSE: BHP) are down more than 20%, FCX is down almost 40% since the start of the year.
FCX's estimates for operating cash flow in 2016 and 2017 were based on oil prices averaging $56 per barrel. Prices are now half of that. A $5 per barrel drop in oil prices would reduce FCX's operating cash flow by $170 million. Assuming that prices average $26 per barrel this year and $31 per barrel in 2017, operating cash flows would reduce by $1.02 billion in 2016 and $850 million in 2017.
So how much is FCX worth in the present price environment? I believe that the fair value for FCX is $12 per share in the present environment. The only hope for FCX is if it can offload the oil & gas business. But in the present environment that looks like a difficult task.
Disclosure: I am/we are long FCX.
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.