These 4 Measures Indicate That Freeport-McMoRan (NYSE:FCX) Is Using Debt Extensively

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Freeport-McMoRan Inc. (NYSE:FCX) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Freeport-McMoRan

How Much Debt Does Freeport-McMoRan Carry?

As you can see below, Freeport-McMoRan had US$9.50b of debt at June 2023, down from US$11.1b a year prior. On the flip side, it has US$6.68b in cash leading to net debt of about US$2.81b.

How Strong Is Freeport-McMoRan's Balance Sheet?

The latest balance sheet data shows that Freeport-McMoRan had liabilities of US$4.79b due within a year, and liabilities of US$20.1b falling due after that. On the other hand, it had cash of US$6.68b and US$1.09b worth of receivables due within a year. So it has liabilities totalling US$17.1b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Freeport-McMoRan has a huge market capitalization of US$52.8b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Freeport-McMoRan has a low net debt to EBITDA ratio of only 0.36. And its EBIT covers its interest expense a whopping 12.1 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. It is just as well that Freeport-McMoRan's load is not too heavy, because its EBIT was down 40% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Freeport-McMoRan can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, Freeport-McMoRan recorded free cash flow of 46% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

While Freeport-McMoRan's EBIT growth rate has us nervous. For example, its interest cover and net debt to EBITDA give us some confidence in its ability to manage its debt. Looking at all the angles mentioned above, it does seem to us that Freeport-McMoRan is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Freeport-McMoRan is showing 1 warning sign in our investment analysis , you should know about...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.