After Freeport-McMoRan's (FCX) startling acquisition announcement in December, we at T&T Capital Management profiled the company to examine the potential implications for an investor. Not much has changed since the time of the acquisition so I just wanted to mainly focus on the 4th quarter and full year earnings results.
I'm quite surprised that more institutional investors haven't expressed frustration with the acquisitions, as I see them materially enhancing the risk profile of the company. There was already enough uncertainty pertaining to long-term copper and gold prices, which have been boosted by extensive Chinese hard-asset expansion over the last decade, and for gold the uncertainty that has been a staple of the market since late 2007. Betting on two aggressively positioned energy companies and leveraging the balance sheet has put the company in a position where any significant recession could put extreme pressure on the firm, potentially forcing the disposal of some key assets at inopportune times. Of course there is more upside now for the company due to the leverage that the deals bring, but if I would have been a shareholder at the time I would have preferred the company bought back its own stock more aggressively, as opposed to venturing into a completely different industry where there are no synergies.
On January 22nd, Freeport-McMoRan Copper & Gold Inc. reported reasonably strong 4th quarter earnings. Net income was $743MM, or $0.78 per share, compared with net income of $640MM, or $0.67 per share one year ago. For the full year 2012 earnings were down to $3 billion, or $3.19 per share, from $4.6 billion and $4.78 per share in 2011. In the 4th quarter FCX sold 972 million pounds of copper, 254 thousand ounces of gold and 21 million pounds of molybdenum. Last year at the same time the company sold 823 million pounds of copper, 133 thousand ounces of gold and 19 million pounds of molybdenum. For the full year 2012, the company sold 3.65 billion pounds of copper, 1 million ounces of gold and 83 million pounds of molybdenum. These numbers were weaker than 2011 when FCX sold 3.7 billion pounds of copper, 1.4 million ounces of gold and 79 million pounds of molybdenum. Operating cash flows in the 4th quarter were $1.3 billion and $3.8 billion for full year 2012, compared with $746MM in the 4th quarter of 2011 and $6.6 billion for the full year 2011.
Consolidated unit net cash costs averaged $1.54 per pound of copper for the 4th quarter 2012, compared with $1.57 at the same time last year net of by-product credits. FCX averaged realized price per pound of copper was $3.60 in the 4th quarter and $3.60 for the full year 2012, versus $3.42 in the 4th quarter of 2011 and $3.86 for FY 2011. The average realized price per ounce of gold in the 4th quarter was $1,681 and for the full year 2012 it was $1,665. These numbers were up slightly from last year's 4th quarter and full year results of $1,656 and $1,583, respectively. Molybdenum prices were down in 2012 versus 2011. Freeport ended the year with a strong balance sheet pre-acquisition, with $3.7 billion of consolidated cash, versus total debt of $3.5 billion.
The company is much more optimistic in 2013, with expectations for sales of 4.3 billion pounds of copper, 1.4 million ounces of gold and 90 million pounds of molybdenum. For the first quarter of 2013, the company expects to sell 940 million pounds of copper, 230 thousand ounces of gold and 23 million pounds of molybdenum. FCX hopes to generate operating cash flows of about $7 billion in 2013, excluding the impact of the two large acquisitions. Capital expenditures are expected to be around $4.6 billion for 2013, which would peg free cash flow at about $2.4 billion to fund the dividend and debt pay-down. The company believes that for 2013 consolidated unit net cash costs should average $1.35 per pound of copper assuming $1,700 per ounce prices for gold, and $11 per pound prices for molybdenum.
Longer-term the company is well position to grow its copper production from 3.66 billion pounds in 2012 to over 5 billion pounds per annum in 2015. Much of this growth will depend on metals prices remaining buoyant, because if prices drop considerably FCX would likely curtail some of the developments, as they would no longer be as attractive from an economic perspective. 2012 had more bad than good for Freeport overall, as its giant Indonesian Grasberg mine had much higher costs and lower ore grades than it did in 2011, but the company believes that these problems should be resolved by late 2013. FCX expects 40% higher gold volumes in 2013 from Grasberg. This mine is a true powerhouse, as it has the highest copper and gold reserves in the world. The company continues to expand its Cerro Verde mine in Peru and its Morenci mine in Arizona, which both should help the company meet its aggressive long-term growth plans.
Freeport-McMoRan has years of high quality, low-cost reserves available, which should generate years of solid income assuming prices of the metals increase at rates ahead of the cost of extraction. The pro-forma EBITDA composition of the company after the two pending mergers that are likely to close in the 2nd quarter of 2013 is still about 75% global mining. FCX will carry about $20 billion of gross debt and $16 billion of net debt. As opposed to being in a zero net debt position like the company is currently at, management intends to maintain a relatively large debt balance which the CFO said would be roughly $12 billion. Freeport plans on continuing upon its $1.25 per share dividend but cutting that would allow the company to pay down debt faster if it did run into any problems down the line. Management has indicated that it struggled to find attractive M&A opportunities in the mining sector, which prompted them to look towards energy and the company is very bullish on commodities in general. I'd rather have a reasonably leveraged FCX that reduces its own share count, as opposed to an albatross of a company that is focused in too many different directions.
FCX has rallied since we last profiled it and the puts we sold have declined in value a bit. At $35.19, the company offers about a 3.5% dividend yield and is one of the most levered plays on a long-term bull market in commodities. China's economic data has been getting stronger but I'm still concerned that much of the growth in hard assets expansion is more of a function of government stimulus, as opposed to truly organic economic growth. Therefore, I believe at some point China is at extreme risk of a hard landing. This could potentially be devastating for a more highly leveraged FCX, not in terms of a likely bankruptcy or anything like that, but the company's hands will be tied when attractive assets get cheaper.
I realize the company took a big chance in 2007 with the Phelps Dodge acquisition that paid off in spades, but I believe this late in the commodities cycle, this is a risky move that wasn't necessary because the company could have just bought its own stock to leverage up for a commodities rally. The reduction in shares would have also reduced the dividend yield, and the cost of debt to leverage up would have been partially mitigated by the corresponding decline in dividend payments, in addition to interest expenses being tax deductible. The $33 2014 FCX puts are selling for $3.50 and I believe would be a reasonable way to play the stock. Selling the put would generate a target profit on maximum risk of 11.9%, and the breakeven price on the investment would be $29.50. At that price, FCX would be offering a 4.23% dividend yield and would offer a larger margin of safety than at the current price. FCX tends to be extremely volatile so if the stock can be acquired in the mid to high 20's, I believe the upside justifies the higher risks associated with the company moving forward.
Disclosure: I am long FCX.