Freeport-McMoRan: Further Sales Needed To Make A Dent In Debt Levels

| About: Freeport-McMoRan Inc. (FCX)
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California oil assets sale will not bring in enough cash to pay short-term debt.

This sale significantly reduces the oil and gas assets from Freeport Oil and Gas.

Removal of under performing oil assets should save cash and enhance EBITDA.

Freeport-McMoRan's (NYSE:FCX) restructuring efforts are continuing as the company has sold another oil and gas asset. The transaction is not huge but it will go some way in strengthening the liquidity of the company. Increased cash position means that the management will be able to meet the debt maturity of over $770 million from internally generated funds. However, the company is still far from being the leaner machine its management is trying to make it.

The oil and gas assets in California were sold for $742 million. The cash inflow, however, will only be $592 million and the remaining payments are conditional. If the average oil price remains $70 or higher per barrel in 2018, 2019 and 2020, then the company will receive a further $150 million. Another nugget of information is that the buyer will assume any future abandonment costs. These costs had book value of $100 million at the end of the second quarter.

While this sale is a positive for the company, it will not have a large enough impact on the balance sheet to move the debt metrics. Freeport-McMoRan has $770 million worth of debt maturing in the current year and around $352 million in cash. This sale will help the company meet that maturity but it will not be enough on its own. Freeport-McMoRan will have to use $178 million from its cash balances to pay off this debt. If we just look at the cash number, then it does not look like a big deal as the overall cash balances should be enough to cover this obligation.

However, further dissection of cash balances reveal that $332 million are in international operations. These funds are earmarked for working capital and other operational needs. Even if the company wants to bring that cash to the country, there will be tax implications. It will not make sense to weaken the liquidity at international operations and incur a tax loss. Therefore, it is safe to assume that there will either be some further asset sales in the near future or the company will tap into the credit facility.

Source: 10-Q

Despite these lean cash balances, the liquidity is not under threat. The company has enough room in its credit facility and cash at hand to meet its liquidity needs. The company amended the credit facility at the start of the year and brought the limit to $3.5 billion from $4 billion. At the end of the last quarter, this facility was almost entirely unused, meaning the company has sufficient liquidity if there is a need to borrow from this facility.

Freeport-McMoRan is on track regarding its targets for balance sheet enhancement. However, sale of its energy business can go a long way in achieving the goal. The oil and gas segment has more than $2.5 billion in outstanding in notes and debentures. The image below shows a breakdown of its outstanding debt.

Source: 10-Q

The company was working on a plan to spin off this segment but the market conditions did not make sense. The prices were too low and it would have been an uphill task to generate interest in an IPO. However, as oil prices have started to recover and the question is that are these remaining assets enough for a spin-off? 83% of total production and revenue for the oil and gas segment came from the Gulf of Mexico and California assets. These two areas generated $1.4 billion in revenues and 120 MMBOE of sales. Clearly, the remaining assets are not enough for a spin-off and a separate sale looks like a viable option. Selling these assets should not be a problem now due to the optimism in the oil and gas sector. Sale of these and the removal of related debt should bring down the debt levels substantially. Gulf of Mexico and California assets accounted for $1.64 billion in combined capital investment in 2015. The sale of these assets also saves the company considerable amount in cash spending.

Current long-term debt is over $18.5 billion and it goes above $19.3 billion if we add the short-term portion as well. Adjusted EBITDA for 2015 was $2.215 billion. Simple EBITDA figures were -$9.8 billion but the company had recorded heavy impairments. Total adjustments amounted to $12.1 billion. As adjusted EBITDA was so weak, the debt metrics shot up and entered the danger zone. Based on these adjusted EBITDA figures, we get a debt/EBITDA ratio of 8.7x. A debt/EBITDA ratio of this magnitude causes a ratings downgrade. However, sale of oil and gas properties should improve debt metrics considerably. A higher realized price for copper during the current year and elimination of oil and gas losses should allow the company to achieve its target EBITDA of $4.5 billion. This means that the debt/EBITDA ratio will come down to 4.1x if we do not assume further decline in debt levels. If the company is able to reduce its debt by the end of the year, this ratio should come down.

Overall conditions in the industry remain volatile. Copper prices have been declining and the Chinese data has not helped. Industrial production went down in September and this looks to have spooked the market. A strong dollar has also adversely affected the base metals market. Freeport-McMoRan has improved its structure and operations. There might be some short-term volatility due to the industry conditions, but it looks a good bet for strong turn around in the long term.

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