Commodity prices have been low for some time amid an economic slowdown in China. Some analysts are just now downgrading their ratings on commodity businesses as the effect of persistently low prices on company balance sheets becomes blindingly obvious.
On Tuesday, Christopher LaFemina, an analyst at Jefferies, joined the growing chorus of analysts with a negative commodity outlook. He downgraded Freeport-McMoran (FCX) to Hold from Buy and Peabody Energy (BTU) to Underperform from Hold.
In the case of Freeport's downgrade, LaFemina cited lower projected copper prices, risks in Indonesia, and the company's "reluctance" to sell assets -- such as its oil and gas holdings. LaFemina also said that Freeport's window of opportunity for fixing its balance sheet may have closed.
"Asset sales would have unlocked significant value as Freeport traded at a large discount to its sum-of-the parts value," LaFemina wrote. So far, the company announced a series of cost-cutting measures that include suspending its dividend and reducing capital expenditures.
The Arizona-based natural resources company has a $20 billion debt load and has "no way to meaningfully reduce debt other than highly dilutive equity issuances," LaFemina wrote.
Shares of Freeport closed down 20% on Monday as the copper futures fell below $2 a pound.
Meanwhile, LaFemina downgraded Peabody Energy, a Missouri-based coal mining company, on balance sheet risk. The company has $6 billion in debt, and its net debt is 22.3x LaFemina's 2016 EBITDA estimate. For perspective, a debt to earnings ratio above 5 is considered a sign that a company will have difficulty meeting its debt obligations.
Given low prices, a stronger U.S. dollar and weakening demand from China, LaFemina doesn't expect Peabody to generate enough cash to "meaningfully" reduce debt.
As for a sign of how bad things could get, on Monday, Arch Coal (ACI), another Missouri-based coal mining company, filed for Chapter 11 bankruptcy protection and cited "changes in the demand" for coal in its filing with the Securities and Exchange Commission.
With the widely known troubles in the commodities business and examples of companies filing for bankruptcy protection, the Jefferies downgrades Tuesday confirm what much of the industry has already known.