Debt is often viewed as a significant risk factor for investors, but is it truly the most accurate measure? Warren Buffett challenges this notion by stating that “Volatility is far from synonymous with risk.” While debt can be a useful tool for companies seeking capital for growth, it can also lead to financial distress if mismanaged. This article explores the debt landscape of Freeport-McMoRan Inc. (NYSE:FCX) and uncovers potential risks that may not be immediately apparent.
When does debt become dangerous? Debt becomes risky when a company struggles to meet its financial obligations, leading to potential bankruptcy or shareholder dilution. Freeport-McMoRan, like many other companies, utilizes debt as a financial resource. The crucial question to consider is how much risk this debt creates for the company.
Let’s take a closer look at Freeport-McMoRan’s debt. As of June 2023, the company had a total debt of US$9.50 billion, a reduction from the previous year’s US$11.1 billion. However, it also possesses US$6.68 billion in cash, resulting in a net debt of approximately US$2.81 billion.
Analyzing the latest balance sheet data, we find that Freeport-McMoRan has short-term liabilities of US$4.79 billion and long-term liabilities of US$20.1 billion. Offsetting these obligations are cash reserves of US$6.68 billion and receivables valued at US$1.09 billion. While the liabilities may seem substantial, the company’s strong market capitalization of US$57.6 billion provides the potential to fortify its balance sheet through capital raising if needed.
To assess the impact of debt on Freeport-McMoRan’s earnings power, we consider its net debt-to-EBITDA ratio, which stands at 0.36—an indication that the company’s debt load is relatively low. Additionally, its EBIT covers its interest expense 12.1 times over, suggesting that the company is comfortably managing its debt obligations relative to its earnings. Although Freeport-McMoRan experienced a 40% decrease in EBIT over the past year, it is important to note that future earnings play a vital role in the company’s ability to maintain a healthy balance sheet.
However, it is crucial to remember that a company can only repay debt with actual cash flow, not accounting profits. In Freeport-McMoRan’s case, its free cash flow over the past three years amounted to only 46% of EBIT, which is lower than expected. This weak cash conversion makes handling indebtedness more challenging.
In conclusion, Freeport-McMoRan’s debt situation presents certain risks that should not be overlooked. Although the company’s interest cover and net debt-to-EBITDA ratios are encouraging, its declining EBIT growth rate raises concerns. While leverage can enhance returns on equity, investors should remain cautious. It is essential to consider both the balance sheet and other factors when evaluating investment risks. For a comprehensive understanding of debt’s impact, investors must go beyond quantitative data.
Q1: Is debt the only factor that affects a company’s risk?
A1: No, debt is only one aspect of a comprehensive risk assessment. Other factors, such as cash flow, earnings, and market conditions, also contribute to a company’s risk profile.
Q2: What is the net debt-to-EBITDA ratio?
A2: The net debt-to-EBITDA ratio measures a company’s ability to repay its debt using its EBITDA. It indicates the proportion of debt relative to the company’s earnings power.
Q3: How does Freeport-McMoRan handle its debt obligations?
A3: Freeport-McMoRan manages its debt obligations well, with its EBIT covering its interest expenses comfortably. Additionally, the company has the potential to strengthen its balance sheet through capital raising if necessary.