Freeport Ends 2012 On A Positive Note - Should You Be Satisfied?

| About: Freeport-McMoRan Inc. (FCX)

Freeport-McMoRan Copper & Gold (NYSE:FCX) saw its shares increase yesterday as fourth quarter profits and revenues beat estimates. The company said that it expects to grow copper production from 3.66 billion pounds in 2012 to over 5 billion pounds per year in 2015.

The world's largest publicly listed copper producer announced last month that it would enter the energy business through acquisitions of Plains Exploration & Production Co (NYSE:PXP) and McMoRan Exploration Co (NYSE:MMR). The $9 billion deal has garnered much media attention since its announcement and has been criticized by investors as an expensive and unnecessary distraction. The company reiterated that it will not give its shareholders a vote on its planned acquisitions of two oil and natural gas companies. The deals are expected to close in the second quarter of 2013.

FCX reported headline EPS of $0.78 and adjusted EPS $0.74 for 4Q12, beating consensus estimates of $0.70 by 6%. Lower cash costs, higher copper sales volumes, and strong realized molybdenum pricing all drove better than expected results.

North American copper sales were down 10 million pounds Y/Y to 321 million pounds; however, average realized prices were up 5.5% to $3.63 per pound. 4Q copper unit cash costs (after by-product credits) rose 20% Y/Y to $1.78 per pound. Increased mining and milling rates drove Y/Y increase in costs.

Freeport has a number of operating and development activities at its North American operations as the company plans to increase production at its North American mines. The company continues the ramp-up of mining activities at Chino, with annual production expected to increase to approximately 250 million pounds by 2014.

At Morenci, the company is in the process of adding additional mining and milling capacity to increase milling rates to approximately 115,000 metric tons of ore per day and mining rates from 700,000 short tons per day to 900,000 short tons per day. The $1.4 billion project is expected to add approximately 225 million pounds of incremental annual copper production by 2014, an approximate 40 percent increase from 2012.

The company expects copper sales from its North American operations to increase y/y in 2013, from 1.35 billion pounds in 2012 1.45 billion pounds in 2013, primarily reflecting higher production at Morenci and Chino. However, due to lower molybdenum credits and higher mining rates, North American copper mines cash costs are also expected to increase by 9% in 2013 to $1.82 per pound.

South American copper sales were down 7 million pounds Y/Y to 350 million pounds and average realized prices increased by 15 cents to $3.60 per pound. Gold sales 26,000 ounces was down 7% Y/Y but up 30% sequentially. Average realized prices also improved Y/Y by 3.7% to $1,686 per ounce.

At Cerro Verde, the company is engaged in $4.4 billion large-scale expansion project to expand the concentrator facilities from 120,000 metric tons of ore per day to 360,000 metric tons of ore per day. The project is expected to add annually 600 million pounds of copper and 15 million pounds of molybdenum to FCX's portfolio beginning in 2016.

South American copper sales are expected to increase by 6.4% in 2013 and gold sales by 71%, largely due to higher grade ore at Candelaria.

Grasberg copper production increased by 194% and copper sales by more than 300% Y/Y. The significant increase from the previous year was largely due to labor related disruptions and temporary suspension of milling operations in 2011. Gold production and sales increased by 48% and 120% respectively. On the other hand unit cash costs were down 63% to $1.33 per pound of copper.

FCX expects unit cash costs to improve materially in 2013 and would approximate $0.68 per pound of copper.

Freeport generated $1.3 billion in operating cash flow before working capital in 4Q12, up from $746 million in the same quarter in 2011. For the full year 2012, the company generated total of $3.8 billion in operating cash flow before working capital, down from $6.6 billion a year earlier. However cash flows are expected to surge again in 2013. Assuming average prices of $3.65 per pound of copper, $1,700 per ounce of gold and $11 per pound of molybdenum, the company is expecting to generate ~$7 billion in operating cash flows in 2013, excluding results of pending acquisitions. $7 billion estimate CFO includes $450 million from net working capital sources and other tax payments.

The company ended the year with consolidated cash of $3.7 billion or $2.7 billion, net of withholding taxes and non-controlling interests' share, in net cash available. At December 31, 2012, FCX had $3.5 billion in debt and $1.5 billion available on its credit facility.

FCX is trading at a price to earnings ratio of 11.4 compared to the industry average of 14, and company's own five year average of 11.6. It has a forward P/E of 8.2. It has both price to book and price to sales ratios of 1.9 vs. the industry averages of 2.9 and 2.8 respectively. Freeport has a very attractive dividend yield of 3.7%.

Bottom Line

FCX is no longer an investment for those seeking for a pure play on copper, but those investors are most probably already out by now. Freeport dropped 16% last month following the announcement of acquisitions. Chairman James Moffett and Chief Executive Richard Adkerson said in a press release that the company is positive about the opportunities that pending oil and gas acquisitions will provide.

"We are positive about the long-term outlook for our business, the markets we serve and the opportunities that the pending oil and gas acquisitions will provide. We are focused on executing our strategy of developing long-term resources in a cost effective and financially attractive manner to generate long-term value for shareholders", the CEO said.

FCX expects to realize increased copper and gold sales volumes in 2013 largely as the result of gaining access to higher grade ore at Grasberg in the latter part of the year. Moreover higher grades in South America and higher production in North American and Africa are also expected to benefit copper sales in 2013.

Our initial view of FCX's foray into energy sector was negative, and we still maintain that view. Although we have a constructive view of the copper market, which we believe will stay tight through 2013, this is offset by increased leverage and lack of expected free cash flow from the energy assets. However, we believe if the deal is put into jeopardy by a shareholder vote (which is highly unlikely) or any doubt about the success of the deal, it will result in a sharp increase in the share price.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.