Carl Icahn Joins Freeport-McMoRan In Struggle Against Weak Commodity Prices

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Freeport-McMoRan Inc. (NYSE:FCX) is facing challenging business conditions. The sharp downturn in copper prices over the course of the last twelve months has negatively impacted the business prospects of the world’s largest publicly traded copper producer. The bad news for Freeport is that it’s not just weak copper prices that the company must deal with, but also weak oil prices. In 2013, the company entered the oil and gas business through the acquisitions of Plains Exploration & Production Company (PXP) and McMoRan Exploration Co (MMR). With its entry into the oil and gas space, Freeport hoped to capitalize on the opportunity afforded by burgeoning oil prices, as well as diversify the risk of being too reliant on one commodity. However, with the recent downturn in oil prices, Freeport has to deal with weak oil prices on top of weak copper prices. The company management has recently taken certain business decisions in response to the twin threat of weak copper and oil prices. In the midst of this struggle for Freeport, noted investor Carl Icahn has recently acquired an 8.5% stake in the company. [1] In this article, we will take at look at the challenges facing Freeport and what Carl Icahn’s investment could mean for the company going forward.

Weak Copper Prices

Copper Prices, Source:LME

London Metal Exchange (LME) copper prices currently stand around 22% lower year-over-year. This is primarily due to demand-side weakness as a result of slowing Chinese economic growth. China is the world’s largest consumer of copper, accounting for over 40% of the global demand for the metal. [2] Since copper is a metal with extensive industrial applications, weakness in the Chinese manufacturing sector, as illustrated by Chinese Manufacturing Purchasing Managers Index (PMI) data, is primarily responsible for the weakness in demand for copper. The Manufacturing PMI is a composite indicator of business conditions in the manufacturing sector of the concerned economy. A value above 50 indicates growth in the manufacturing sector, compared to the previous month, whereas a value below 50 indicates a contraction. The following chart illustrates the weakness in the Chinese manufacturing sector over the course of this year.

Chinese Manufacturing PMI data, Source: Trading Economics

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The weakness in demand for copper is indicated by faltering Chinese imports of the metal, which declined 8.1% year-over-year in the first eight months of 2015. [3] With Chinese economic growth expected to slow further next year, copper prices are expected to remain subdued in the near term.

Weak Oil Prices

As mentioned previously in the article, on top of weak copper prices, Freeport has to contend with weakness in oil prices, too. Oil prices have tumbled over the last twelve months due to a global supply glut. Brent crude oil prices are currently trading at $48 per barrel, roughly 53% lower year-over-year. [4] Rising oil and gas output from the U.S., where hydraulic fracturing techniques have helped boost output, has boosted global oil and gas output over the last few years. Though the decline in oil prices has lowered production levels in the U.S., these still remain at fairly high levels. Adding to high U.S. oil and gas output, major oil producers from the Organization of the Petroleum Exporting Countries (OPEC) have not lowered output in response to falling prices, in order to preserve their market shares. With the recent signing of the Iranian nuclear deal, oil and gas production from the region is expected to rise further, adding to the supply glut. Given the prevailing oversupply situation, oil prices are unlikely to recover substantially in the near term.

Freeport’s Response

Over the course of the last month, Freeport’s management has announced reductions in capital spending for both its copper mining and oil and gas divisions, and lowered production guidance for its copper mining business. The company slashed its oil and gas capital expenditure budget for 2016 and 2017 by around 31%, in addition to a 25% reduction to the capital expenditure budget for its mining operations for 2016. [5] Freeport also lowered its copper production guidance for 2016 by 150 million pounds to 5.25 billion pounds. [5]

In addition to spending cuts, Freeport’s management has also tried to reduce the company’s heavy debt burden over the course of the last year or so. Freeport’s total debt stood at around $21 billion at the end of Q2 2015. [6] Freeport’s heavy debt burden is largely a legacy of its oil and gas acquisitions. The company raised $10.5 billion in debt in 2013 to fund the acquisition of PXP and MMR, and assumed an additional $6.7 billion in debt from PXP. [7] The company raised roughly $3.5 billion (on a pre-tax basis) from asset sales in 2014, which were used to pay down the company’s debt. [8] However, considering that S&P lowered the credit rating for Freeport’s debt in Q1, and revised its outlook on the same to negative from stable earlier this month, the company still has a long way to go to convince the market about its debt reduction efforts. [9]

Enter Carl Icahn

Seasoned Wall Street investor Carl Icahn recently acquired an 8.5% stake in Freeport. ((Schedule 13D Filing, SEC)) Carl Icahn has played the role of activist investor in several of his previous investments. As per the Schedule 13D filing for Icahn’s investment in Freeport, Icahn plans to have discussions with company management and board of directors over the company’s capital expenditures, executive compensation practices, capital structure, and curtailment of high-cost production operations. [1]

As mentioned in the previous section of the article, Freeport’s management has already addressed some of the issues raised by Carl Icahn. The company management has already announced reductions to capital spending and is working to reduce the company’s debt. Further, it has also announced a small reduction to its production guidance for next year. Icahn’s intervention may prompt the company management to address these issues with greater rigor. Whereas the company management can curtail high-cost operations and has already significantly lowered its capital spending for next year, given the weak commodity pricing environment, reducing the company’s debt organically would be an extremely challenging task. Asset sales are a realistic way to reduce Freeport’s debt, but the company is unlikely to realize good value for any asset sales under current market conditions. Thus, apart from giving fresh impetus to Freeport’s efforts to tackle a tough operating environment, barring a recovery in commodity prices, Icahn’s investment is unlikely to significantly boost the company’s business prospects.

If Icahn is unlikely to significantly alter Freeport’s business prospects, why has he invested in the company? A likely explanation is that an investment into Freeport looks like a shrewd move that could reap handsome returns in a few years time. We are currently near the bottom of the commodity cycle. The company’s stock has fallen nearly 70% over the course of the last twelve months, as illustrated by the chart shown below, and is trading at roughly 0.5x revenues.

FCX Stock Price, Source: Google Finance

Whereas copper prices are likely to remain weak over the next year or so, low copper prices have resulted in a reduction in investments in new copper mining projects globally. [10] This could result in a tightening of copper supply in the future, particularly if demand for copper recovers faster than expected. A more favorable demand-supply equation in the future is likely to boost copper prices, and Freeport’s stock price.

It remains to be seen whether or not Mr. Icahn is able to push Freeport’s management to address the challenges facing the company with renewed vigor, or on a faster timetable. However, given the stock price at which Icahn has invested in Freeport, it certainly looks like he’s made a good investment.

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Notes:
  1. Schedule 13D Filing, SEC [] []
  2. Copper hits 6-year low as China equities drop, Financial Times []
  3. China monthly copper imports flat in August, Reuters []
  4. Brent Crude Oil Prices, Y Charts []
  5. Freeport-McMoRan Announces Further Spending Cuts in Response to Market Conditions, Freeport-McMoRan News Release [] []
  6. Freeport-McMoRan’s Q2 2015 10-Q, SEC []
  7. Freeport-McMoRan’s 2013 10-K, SEC []
  8. Freeport-McMoRan’s Q3 2014 10-Q, SEC []
  9. S&P Lowers Outlook on Freeport-McMoRan (FCX) to Negative; Sees Elevated adj.-Debt-to-EBITDA, StreetInsider.com []
  10. Copper producers position for price recovery, Financial Times []