When it comes to investing, assessing the risk of a company is crucial. While some argue that risk should be measured by volatility, others believe that debt is a better indicator. Warren Buffett famously said that “Volatility is far from synonymous with risk.” So, how risky is Freeport-McMoRan Inc. (NYSE:FCX) and its use of debt?
Debt can be beneficial for a business as long as it can be paid off. However, if a company cannot pay its debts, it can lead to bankruptcy or the need to raise new equity capital at a low price, which dilutes shareholders’ value.
At the end of June 2023, Freeport-McMoRan had a total debt of US$9.50 billion, a reduction from US$11.1 billion the previous year. However, it also had US$6.68 billion in cash, resulting in a net debt of approximately US$2.81 billion.
Looking at the balance sheet, Freeport-McMoRan had short-term liabilities of US$4.79 billion, and long-term liabilities of US$20.1 billion. Offsetting these obligations, it had US$6.68 billion in cash and US$1.09 billion in receivables due within 12 months. Despite the high amount of liabilities, Freeport-McMoRan has a large market capitalization of US$57.6 billion, which means it could potentially raise capital to strengthen its balance sheet if needed.
When evaluating a company’s debt load, it is essential to consider its earnings power and ability to cover its interest expenses. Freeport-McMoRan has a low net debt to earnings before interest, tax, depreciation, and amortization (EBITDA) ratio of 0.36, indicating its debt is manageable. Additionally, its EBIT covers its interest expense 12.1 times over, showing that it has sufficient earnings to meet its interest obligations.
However, Freeport-McMoRan’s EBIT has declined by 40% in the past year, which raises concerns about its ability to pay off debt in the future. Future earnings will be crucial in determining whether the company can maintain a healthy balance sheet going forward.
It’s important to note that a company can only pay off debt with actual cash flow, not just accounting profits. In Freeport-McMoRan’s case, its free cash flow in the past three years amounted to only 46% of its EBIT, indicating weak cash conversion and making it more challenging to handle its indebtedness.
Overall, Freeport-McMoRan’s use of debt does pose some risk. While leverage can increase returns on equity, it is essential to consider the company’s ability to generate future earnings and generate sufficient cash flow to pay off its debts. Investors should carefully evaluate these factors before making any investment decisions.
– Simply Wall St
– (email editorial-team (at) simplywallst.com)
– Net Debt: The sum of a company’s short-term and long-term debt after subtracting its cash and cash equivalents.
– EBITDA: Earnings Before Interest, Tax, Depreciation, and Amortization. It measures a company’s operating performance.
– EBIT: Earnings Before Interest and Tax. It reflects a company’s profitability before accounting for interest and tax expenses.
– Cash Flow: The net amount of cash and cash-equivalents entering and leaving a company.
– Market Capitalization: The total value of a company’s outstanding shares in the stock market.