Three weeks ago we wondered when Moody's would finally get the Freeport McMoRan joke when, with its stock crashing to unseen lows, it would finally cut investment-grade rated FCX (Baa3) to its rightful place deep in junk territory:
As we noted then "the US copper and gold producer has seen its 5-yr CDS spread trading at implied junk levels for the last six months. Troubles have intensified over the past month and credit spreads now imply a 79% chance of default within the next five years."
We got the answer last night, when Moody's finally slashed its rating on the copper miner by four notches, from Baa3 to B1 saying "the downgrade reflects an increase in leverage stemming from a severe drop in copper prices last year."
Moody's downgrades FCX's ratings, assigns B1 CFR; outlook negative
Moody's Investors Service downgraded the senior unsecured ratings of Freeport-McMoRan Inc (FCX), and Freeport-McMoRan Oil & Gas LLC (FMOG) to B1 from Baa3. The rated debt instruments at FCX and FMOG are cross guaranteed by the respective holding companies. The ratings for Freeport Minerals Corporation were downgraded to Ba2 from Baa2. The rated debt instruments at Freeport Minerals Corporation (formerly Phelps Dodge) have a downstream guarantee from FCX. At the same time, Moody's assigned a B1 Corporate Family Rating (CFR), a B1-PD Probability of Default rating and an SGL-2 Speculative Grade Liquidity rating to FCX. The outlook is negative.
The downgrade reflects the deterioration in FCX's debt protection metrics and increase in leverage as a result of the more precipitous drop in copper prices in 2015, particularly in the last six months of the year as well as the collapse in oil prices, with prices continuing to be pressured downward in 2016. Based upon the company's year-end reporting, we estimate that leverage, as measured by the debt/EBITDA ratio, is around 6x incorporating Moody's standard adjustments.
But most ominously, Moody's added the following striking warning:
We believe that the current environment is not a normal cyclical downturn but a fundamental shift in the operating environment for these commodities. As a consequence, a wholesale recalibration of ratings in the mining industry is deemed necessary. With the downturn expected to be deeper and longer, any material improvement in metrics will be protracted, absent the company's ability to execute on its objective of reducing debt through asset sales and joint venture transactions. While we recognize that FCX has undertaken a number of steps throughout 2015 to respond to deteriorating market conditions, the ongoing ability to further adjust to a lower price environment is expected to be more challenging and the timing and execution of asset sales is uncertain.
In other words expect even more downgrades not only for FCX but for all its peers, and certainly for Glencore which we expect wil be downgraded any moment.
Then, overnight RBC had the following words of caution when it cut its FCX price target once again, from $8.00 to $6.50:
Our view: At current spot prices, we estimate that Freeport would have a cash shortfall of $1.8 billion over the next two years. Freeport has $4 billion of room on its revolver, but there is a risk that the company could breach its debt covenants by the end of 2016. As a result, Freeport is pursuing asset sales to reduce debt, including the $2.0 billion in maturities over the 24 months. At the same time, uncertainty remains with respect to ongoing negotiations with the Indonesian government. We expect the risks associated with asset sales and debt repayment, and the situation in Indonesia, to continue to weigh on the share price. We maintain our Sector Perform recommendation and reduce our price target to $6.50.
Asset sales required to reduce debt: With $20.4 billion of debt on the balance sheet, $2.0 billion of maturities over the next 24 months, and little in the way of free cash flow at current prices, Freeport is focused on selling assets to reduce debt. The company has made it clear that it is trying to sell not only the O&G assets but also its mining assets. The company is targeting debt reduction of $5–10 billion.
Balance sheet and funding sensitivity: At spot prices, we estimate that Freeport would have a cash shortfall of $1.8 billion through 2017 and a much larger shortfall in 2018. The revolver should provide sufficient liquidity through 2017. However, the risk of a covenant breach and the large shortfall in 2018 highlight the need for asset sales.
As a result the joke today is on FCX shareholders who found a brief respite in yesterday's torrid rally, which has fully roundtripped today.