Freeport McMoRan has a problem. And it can be traced back to its decision to buy into the oil and gas market in 2013. The outcome, a massive increase in debt at a time when commodity markets were plummeting, has left this natural-resource company floundering. Does it have too much debt?
That was then ...In 2013, Freeport made a choice that increased its debt load from around $3.5 billion to $20 billion in a year. Debt remains at around that level today, roughly two years later. The choice? To acquire McMoRan Exploration Co. and Plains Exploration. The deal, which many suggest was an attempt to salvage investments it had made in these companies, cost $20 billion. That consisted of $9 billion for the two companies and the assumption of around $11 billion of debt.
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Freeport's oil shift didn't turn out to be such a gusher. Source: Chappell, Oil City, Pa., via Wikimedia Commons.
With oil prices at the time bucking the broader commodity downtrend, you could have argued it was a good call to expand into the oil and gas space to help prop up the rest of its business. Hindsight, which is 20/20, has proven that it wasn't. Oil has fallen hard from its mid-2014 highs. So Freeport took on a huge load of debt right when it was least capable of shouldering it. (It also issued a cool 50 million shares, too, adding dilution to the list of negatives from this deal.)
... This is nowSo, a couple of years later, we know buying into oil and gas was a bad move. Like all other commodity players, Freeport has been retrenching to keep its expenses in check. There's nothing wrong with that; it's the right move in a difficult market. But Freeport has more at stake than other players.
Debt currently makes up around 50% of the company's capital structure. Compare that with other large miners such as BHP Billiton and Newmont Mining, where debt is closer to a third of the capital structure. That difference wouldn't be such a big deal if these companies' top and bottom lines weren't tied to often volatile commodities. In the world these miners live in, less debt is better and Freeport has taken its debt load in the wrong direction at the wrong time.
In fact, before the oil buy, debt made up just 15% or so of the company's capital structure. Without the deal, Freeport would be in a much better financial position today. But what does that mean? Before the acquisition, in 2012, interest expense ate up just 3% of the company's earnings before interest and taxes-- EBIT. Impairment charges of nearly $5.8 billion make it hard to do a direct comparison through the first six months of this year. However, if we pull those costs out, interest expense was a massive 65% of the company's EBIT.
That doesn't leave much room for error or a further weakening of the commodity markets. Which is why Freeport has announced another round of capital spending cuts and has plans to issue more shares -- even though it will be a dilutive move. It pretty much has no choice but to raise cash any way it can to get its debt load down.
Survival of the fittestIf you're looking for a commodity player that's getting better through the downturn, Freeport isn't it. The company is currently in survival mode, doing everything it can to keep its head above water. And debt is proving to be a heavy weight dragging it down. There's no way to tell if the miner and oil driller will or won't make even bolder moves, that could be even worse for shareholders than dilutive share issuances, but it is pretty clear that Freeport isn't the financially strong company it was just a few years ago. If you own Freeport or are looking at it, debt is a problem you'll want to keep a very close eye on.
The article How Big an Issue Is Freeport McMoRan's Debt? originally appeared on Fool.com.
Reuben Brewer has no position in any stocks mentioned. The Motley Fool owns shares of Freeport-McMoRan Copper & Gold,. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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