Freeport-McMoRan - Still a Strong Buy
Freeport-McMoRan Copper & Gold (FCX) is the second largest copper producing company and is a major producer of gold and molybdenum. FCX's mines are located in Indonesia, North America, South America and Africa. In December 2012, FCX announced plans to acquire Plains Exploration & Production (PXP) and McMoRan Exploration (MMR) in a cash and stock deal valued at $20 billion, including the assumption of debt. These mergers are expected to close in the second quarter of 2013.
At the time of this article, Freeport's current price is $28.24 - close to its 52-week low of $27.24 - with a current PE of 8.85, a forward PE of 6.29 and a dividend yield of 4.4%.
1Q13 Earnings Call Highlights
Management kept their estimates in place regarding future outputs with the mine sequencing at Grasberg, resulting in higher grade ores and copper production later in 2013. The brownfield development projects are on track and are expected to increase output of copper by 975 million pounds, gold 800,000 ounces, and molybdenum 17 million pounds per year by 2015.
Cash costs of copper mining on a consolidated basis have increased from $1.48 in year 2012 to $1.57 for 1Q13. In addition, the estimates for consolidated cash costs for 2013 have increased from an estimate of $1.35 at 4Q12 conference call to $1.45 on the 1Q13 call. The estimate increase is a result of increased costs in North and South America partially offset by a decrease in Indonesia.
The potential acquisitions noted above are expected to complete in 2Q13 with a vote on Plains scheduled for May 20. These acquisitions will diversify FCX from relying solely on copper while also providing the opportunity to add substantial oil and natural gas reserves. The $16 billion in debt from these acquisitions is expected to be substantially paid off by 2016 (depending on copper prices).
China Slowdown Debunked - The stock price has dropped significantly over the past two weeks apparently because of a perceived slowdown in economic activity in China as well as an article from Goldman Sachs stating gold has peaked. As a result, commodity prices plummeted, taking mining stocks down as well. The mainstream media provided significant coverage of the drop in gold prices, but failed to cover the fact that the Chinese Yuan [CNY] recently hit a 19-year high against the US Dollar. The dollar was trading at CNY 6.1723 early on April 17.
This increase in the CNY will allow Chinese manufacturers to obtain raw materials at lower prices, allowing them to also sell finished goods at lower prices to their domestic customers. Consequently, the Chinese consumer will have a higher standard of living by being able to buy more goods at lower prices. The Chinese economy is maturing, and as it matures, it will slow. The process is normal and fighting it only creates inflation and a lower standard of living for the Chinese citizen.
The increase in the CNY is a boon for FCX, as it will allow more materials to be purchased by Chinese industry. The Chinese consumer will also make up for the slack in US demand.
FCX Management has Shareholder Interests in Mind - FCX has paid a consistent dividend, with the exception of 2009. Management rewarded patient shareholders by later issuing two special dividends that made up for the loss dividends and then split the stock 2 for 1.
The elimination of this dividend in 2009 was to conserve cash after the decrease in commodity prices. Management conserved cash flow by making the prudent decision to pay down debt instead of continuing the dividend to keep income investors happy. Senior management and directors are also significant shareholders, so they have a vested interest in growth of the company.
If there is concern about the ability of FCX to pay down the debt incurred from the two recent acquisitions, they can refer back to the previous acquisition of Phelps Dodge, a company 2.5 times FCX at that time. The acquisition incurred $14 billion of debt that was paid down to $6.5 billion by the end of 2008. The caveat here is that copper prices also remained elevated during this time.
Additional Acquisition Opportunities - Prior to the gold selloff, mining companies were already hovering near 52-week lows. During the selloff, many miners hit new lows, and the mainstream media made claims that many could be at risk of having lowered credit ratings. Lowered credit ratings may decrease the market value of these miners to the point they would present a better return on investment than FCX's brownfield projects.
Some of these mining companies may go bankrupt, resulting in untapped reserves not reaching the market and increasing commodity prices, even as demand slows. If the companies do not go bankrupt, they will mothball investments in new projects, decreasing supply.
In contrast, FCX maintained their investment grade credit rating after adding debt to finance their recent acquisitions. Given the history of the company paying down debt, I expect FCX to pay down the debt rapidly to provide opportunities to finance additional acquisitions.
The increased prosperity in China may not offset the slowdown in the US. Copper prices may not recover or continue to fall as the Chinese pull back in their spending. FCX may be unable to realize returns on their acquisitions. Any of these events would weaken FCX's ability to pay down debt as well as take advantage of acquisition opportunities.
At the current price, FCX presents a very good entry point for income and growth investors. In addition, management has a history of financial prudence. For the long-time investors, this presents an opportunity to average down.