Freeport-McMoRan: Any Juice Left?

About: Freeport-McMoRan Inc. (FCX)
by: Orthodox Investor

Goldman analysts have changed their stance on copper.

Next two quarters are going to be good for Freeport-McMoRan due to the bullishness in the copper market.

Debt exchange will not have an effect on the debt metrics, but relaxed covenants will allow the management to better negotiate future debt issues.

Rising EBITDA figures in the next six months will reduce the leverage ratio.

Freeport-McMoRan (NYSE:FCX) has had a great rally since mid-October and the stock has gained more than 50%. The rally has slowed in the last few days as the market waits for the future direction of copper prices. Copper has been on its own rally in the last month and the bullish sentiment is becoming stronger. Goldman Sachs (NYSE:GS) analysts are also finally becoming bullish on the metal and believe the prices will continue to rise through first half of 2017. This is a big turnaround for the investment bank as they were predicting a decline of more than $800/tonne in the next twelve months back in August.

As the base metals started a rally after the US presidential elections, Goldman analysts were still skeptical and believed the rally was mainly due to speculation. However, in their most recent note, Goldman analysts are hinting at a fundamental strength in the commodity. They believe the demand will outstrip the supply in the next six months and we might see a deficit in the market. Previously, there were fears about the oversupply from almost all the major players in the industry. This is what Goldman Analysts said in the research note:

Although it is tempting to blame this on speculative positioning, the materially stronger fundamental developments that contributed to this surge in speculative interest are likely to underpin a more bullish environment for copper.
The improvement in demand growth was much stronger than we had anticipated and appears likely to absorb much of the 'wall of supply' that we had expected would drive prices lower during 2H16 and early 2017.

In the first paragraph, a sheepish tone can be detected which refers to their last position on the commodity when the copper prices started the rally. However, they are now pointing towards actual growth in demand, which is likely to continue. I have been cautiously bullish on the metal, but even I did not expect such a surge in price. The analysts are now predicting a 6-month price of $6,200/tonne. At the moment, the price is around $5,800/tonne.

My cautiously bullish stance on the metal was based on the expectation of a recovering Chinese economy, massive infrastructure spending by the Asia-Pacific and emerging economies and more recently, Donald Trump's plans to invest in mega infrastructure projects. These factors lead me to believe that Goldman's bearish stance on copper will not materialize in the next twelve months. And this was also the reason I was bullish on Freeport-McMoRan. The company was executing its restructuring plans efficiently and the market fundamentals were expected to improve.

Freeport-McMoRan announced an exchange offer for its notes at the end of the last month. These notes were previously issued by Freeport-McMoRan oil and gas. New notes are going to have the same maturities and the outstanding amounts. The only change will be the removal of some covenants and restrictive provisions. FCX has been trying to manage its debt, and while this will not reduce its debt or leverage, it will allow the company to negotiate future debt more independently. Restrictive provisions and covenants often impede a business's ability to negotiate new debt issues. It is not a good idea to be in default of bond covenants. This can spook investors and cause a mayhem. Easier covenants also reduce pressure on the overall credit profile of a business. The image below shows the validly tendered amounts of different bond issues.

Source: Press Release

The management has been successful in attracting bondholders to exchange their bonds. Keep in mind that the validly tendered bonds will be replaced with the identical new bonds. All the bonds which are not tendered, will continue to remain outstanding on previous terms. The lowest tender is 74% for the 2019 notes. However, it still covers the majority of the issue and leaves a small amount. The overall percentage of all the notes tendered shows that the bondholders do not have any qualms about relaxed covenants. This is also a sign of increased confidence in the company's ability to continue working as a going concern. Mind you, there will be no change in interest expense, maturity profile or the debt metrics. Please read this article for detailed analysis of debt metrics and other fundamentals.

Copper price action in the last few weeks means that the company will most likely be able to have a higher average realized price for the fourth quarter. As a result, the earnings are going to be better than the previous quarters. In addition, the bullish sentiment in the first half of the next year will ensure further increase in average realized price. Rising price and controlled expenses will expand profit margins for Freeport-McMoRan. As the average realized prices continue to increase and the cash costs fall, the company will be able to generate more cash. This might also allow it to accelerate its deleveraging efforts in the next 12 months. While the debt exchange will not have an effect on debt metrics, rising EBITDA figures in the next six months will certainly give a better interest coverage and lower leverage ratio.

There is still a lot of juice left in this one. Despite having a strong rally in the last few weeks, the long-term picture is still looking rosy. I do not believe the fundamental improvements in the market have been completely priced in. Current pullback gives a good opportunity to the long-term investors to buy more.

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.