Freeport McMoran FCX

S&P gives Freeport-McMoRan ‘positive’ credit rating, despite $9.7b debt

S&P has revised the outlook for Freeport-McMoRan upward, noting robust commodity prices, vast reserves, diversified production, and a good project pipeline will reduce corporate debt by $1.8 billion this year.

Author: Dorothy Kosich
Posted: Wednesday , 18 Jul 2007

RENO, NV -

Citing expectations that Freeport-McMoRan Copper & Gold will be able to reduce its $9.7 billion debt, Standard & Poor's this week revised its outlook for Freeport and its Phelps Dodge acquisition from "stable" to "positive," affirming all corporate credit ratings.

Primary Credit Analyst Thomas Watters said, "The outlook revision reflects our expectations that Freeport-McMoRan should also be able to reduce its borrowing, specifically the $2.45 billion under its term loan A facility, in a reasonable time frame to warrant an upgrade of the corporate credit rating to investment grade."

"The ratings on Freeport reflect its leading position in copper mining, its significant and diverse reserve base, its very-low cost Indonesian operations, strong liquidity, and currently favorable metals prices," Watters wrote. "The ratings also reflect very aggressive debt leverage, exposure to cyclical and volatile commodity prices, rising costs, challenges faced at its mature, U.S.-based operations, and exposure to the political and sovereign risks of Indonesia."

Watters noted that Freeport should benefits from Phelps Dodge's "good production pipeline potential-specifically, the low-cost Tenke Fungurame project in the Congo, which, is however, exposed to that country's political risk." Nevertheless, he also expressed some discomfort at Freeport's exposure to Indonesia's operating risks through its gigantic Grasberg copper-gold operation, accounting for 38% of Freeport's revenues, 35% of equity production, and 40% of pro forma EBITDA.

"Moreover, while we deem Phelps to be a very good mining operator, " Watters said, "Phelps' U.S. based-operations are mature and relatively high-cost compared to other mining operations, This is primarily of lower ore grades and exposure to U.S. labor, environmental compliance, and energy costs, which are higher than for international mining operations. The company has relied on strict adherence to reducing costs throughout its system while advancing new, lower-cost, and more efficient mining techniques."

While S&P feels Freeport's credit metrics are healthy, they also asserted that it reflects "peak copper, gold, and molybdenum prices and does not indicate our expectations for credit metrics in the future. Despite the considerable paydown of debt, we view the capital structure as aggressive. Nevertheless, Freeport should achieve a more conservative balance sheet based on our outlook for copper, gold and molybdenum prices for the next four to five quarters."

S&P forecast that Freeport will generate a discretionary cash flow of $1.8 billion this year, thanks to robust commodity markets, which will reduce overall debt to $7 billion-$7.2 billion.

In a presentation to the JPMorgan Basics & Industrial Conference Monday, Freeport President and CEO Richard Adkerson said the company expects to have operating cash flows of $5.3 billion this year and year-end total debt of $9 billion. Its mines will produce 3.9 billion pounds of copper, 1.9 million ounces of gold, and 70 million pounds of molybdenum this year, according to Adkerson.

Freeport's PD division is developing the $650 million Tenke Fungurume copper/cobalt project in the DRC, which is anticipated to yield 259 million pounds of copper and 18 million pounds of cobalt in its first decade. Adkerson also gave a project update for the DOZ Expansions in Indonesia including mine development activities at the Grasberg Block Cave during the second half of this year.

Freeport McMoRan Copper & Gold tripled its Q2 net earnings from a year ago on higher metal prices and the $26 billion buyout of copper miner Phelps Dodge, but EPS of $2.62 fell short of the $2.74 analysts were forecasting. Net income rose over 200% to $1.1 billion, while revenue climbed 307% to $5.33 billion. "Our second-quarter financial performance reflects strong results in our North American, South American and Indonesian operations, and a continuation of positive market conditions for copper, gold and molybdenum. The outlook for our business is strong," the company said in its press release. Shares are up 70.5% YTD in apparent appreciation of the acquisition, which made FCX the world's number-two copper company. In a July 6 note, Credit Suisse wrote, "Comparing FCX’s copper, molybdenum, and gold reserves with current North American equity market valuations for the reserves of ‘pure play’ copper, molybdenum, and gold producers suggests FCX shares ($95) are worth $126 per share." Shares are trading slightly higher in the pre-market. Check for Freeport-McMoRan's earnings call transcript later today.

James Cullen submits: Freeport McMoRan: Cheap Producer, Cheap Stock I recently completed my research into Freeport McMoRan (FCX), which acquired Phelps Dodge to become the largest publicly traded copper company in the world. There is much to be interested in here, as the new Freeport now has geographic diversity, excellent reserves, additional promising projects, and exposure to molybdenum.

Here are a few main points to consider:

The Freeport/Phelps Dodge combo trades at a trailing pro forma 4.6x EV/EBITDA. Compare this with other major miners like Southern Copper (PCU) at 6.8x EV/EBITDA, Rio Tinto (RTP) at 7.4x EV/EBITDA, Barrick Gold (ABX) at 10.6 EV/EBITDA, and Newmont Mining (NEM) at 10x EV/EBITDA.

Copper market fundamentals remain positive for Freeport, as supply and demand remain in a very tight balance. Further, a lack of major capacity additions coupled with continued growing demand from China and an eventual uptick in housing starts in America will further add to the demand side. The potential for supply disruptions – as seen with Southern Copper’s miners going on strike in Peru last week – remains a very real threat, as warehouse supplies of copper are also near record lows.

Much of the additional supply that is seen coming to the copper markets in the next few years will be sourced from Freeport’s mines; this should give the company better control over industry-wide production practices, and hence price. With the majority of mines in the latter stages of life and estimated to be depleted by 2021, Freeport is in excellent positioning with its reserve quality and life, as its projects will have a great role in swaying global supply.

This might sound a bit scary, but Freeport does not hedge its production. The company is levered to copper prices, with each $0.10 change in copper resulting in a change of $250M in Operating Cash Flow or $0.75 in EPS. Gold and molybdenum prices both have an impact, although to a much lesser extent. Freeport’s management has a great degree of experience and a reputation for being the lowest cost producer, and their stance on hedging is obviously indicative of a belief that copper prices won’t significantly retreat any time soon. At current prices, Freeport should be able to generate well over $6 billion in Operating Cash Flow.

Using a quick cash flow valuation, I believe FCX is worth north of $85/share. While there might be some uncertainty surrounding this stock given that the latest quarter only including marginal production from Phelps Dodge, I think that next quarter’s fully integrated results will handily beat expectations and send the stock much higher, but make sure to watch the cash, as the accrual results are going to be impacted by accounting items from the deal.