Freeport-McMoRan Copper & Gold Inc. (FCX) is one of the largest mining companies in the world. It has assets in North and South America, Indonesia and the Democratic Republic of the Congo. The company's main products are copper, gold, molybdenum, and oil and gas.
Freeport's Grasberg complex in Indonesia has the largest single recoverable reserve of both copper and gold in the world. In addition to oil & gas operations, the company has five operating divisions: North America Copper Mines, South American Copper Mines, Indonesia Mining, Africa Mining and Molybdenum operations.
Source: Company Documents
FCX, the largest publicly traded copper company in the world, recently reported its 2Q13 adjusted EPS of $0.22, missing consensus estimates of $0.41 by 19 cents. However, despite the earnings miss, we think FCX represents one of the best investment opportunities within the U.S. metals and mining sector.
The reasons why we think FCX presents a good investment opportunity include:
- Attractive copper growth projects pipeline,
- Great capital allocation flexibility,
- Copper / oil leverage,
- Company-specific growth potential,
- Compelling valuation, and
- High dividend yield.
The acquisitions of PXP and MMR represent a significant change in the strategic direction of the company. Even if one would argue that both copper and energy have similar end-market exposures, still these acquisitions represent a significant change in the investment thesis of Freeport for many reasons, including future capital allocation decisions, limitations on a core investor base, and different supply side drivers. These transactions diluted the pure play exposure of FCX.
Therefore, the announcement of Freeport's foray into the energy sector last December came as a surprise to most and our own initial reaction to the news was negative. However, we believe the negative share performance has already priced this in and it's time to move on.
Looking ahead, we believe the 'new' FCX represents a good investment opportunity for various reasons. The company remains an undervalued copper play. The acquisitions of PXP and MMR provide investors diversification with attractive oil and gas assets, the company has significant growth potential, and it has very attractive valuations.
The energy acquisitions have not entirely changed the company. It is still a copper play, only now the company is more diversified than it ever has been. Despite the oil and gas acquisitions, roughly three-fourth of EBITDA in 2013 is still expected to come from the Mining business, with only one-fourth from Oil & Gas.
FCX also has unparalleled company-specific growth potential. It has an attractive pipeline of copper projects that will further grow the cash flow generation of the company over the next 5 years. The major projects in progress include Cerro Verde, Morenci, and Tenke. These projects together should add almost 1 billion pounds of incremental copper production by 2016.
Cerro Verde is an open-pit copper and molybdenum mining complex located approximately 20 miles southwest of Arequipa, Peru. The company is engaged in a large-scale expansion at Cerro Verde. The project would expand the concentrator facilities from 120,000 metric tons-per-day ("mtd") to 360,000 mtd and provide incremental annual production of approximately 600 million pounds of copper and 15 million pounds of molybdenum beginning in 2016.
Source: Company Documents
Morenci is an open-pit copper mining complex located in Southeast Arizona, about 50 miles northeast of Safford. The company is engaged in a project to expand mining and milling capacity at Morenci to process additional sulfide ore identified through exploratory drilling. The project is targeting incremental annual copper production of approximately 225 million pounds in 2014 (an approximate 40 percent increase from 2012) through increases in mining rates to 815 mtd and milling rates to 115,000 mtd.
Source: Company Documents
Located approximately 110 miles northwest of Lubumbashi in the Katanga province of the DRC, the Tenke Fungurume mine includes surface mining, leaching and SX/EW operations. By the end of 2012, FCX completed the phase 2 expansion of the project to optimize the current plant and increase capacity. The expanded mill is capable of throughput of 14,000 metric tons of ore per day, and expanded processing facilities will enable the addition of approximately 150 million pounds of copper per year. The expansion project included mill upgrades, additional mining equipment, a new tankhouse and an additional sulphuric acid plant (which is expected to be completed in 2015).
Source: Company Documents
Freeport has also been in the news for the past two months following a fatal tunnel collapse at its Grasberg complex in Indonesia that killed 28 people. Following the unfortunate event in May; the company declared force majeure at Grasberg mine in June, shutting operations while safety investigations were carried out.
Shipments from the mine, Freeport's largest, resumed earlier this month after the Indonesian government allowed operations to restart. However, the shipments are yet to reach normal levels and FCX expects output to drop by nearly a fifth following a near two-month stoppage. Before the accident, Freeport had expected sales of about 500,000 tons of copper from its Indonesia unit in 2013, along with 1.25 million ounces of gold. Freeport's stock declined ~20% during the near two-month stoppage period.
FCX reported 2Q13 adjusted EPS of $0.22 missing consensus estimates of $0.41 by 19 cents. Reported EPS of $0.49 was adjusted for one-time items including a $0.05 per share charge related to the acquisition of PXP and MMR, a $0.13 per share gain from preferred stock in MMR, and a $0.19 per share gain from deferred tax liability. The miss was driven by higher than expected copper costs, unit net cash costs of $1.85 per pound, and lower gold sales of 173,000 ounces.
Copper sales of 951 million pounds were down just 3 million pounds Q/Q; however, realized price of $3.17 per pound dropped by 34 cents during the same period. At the same time, copper cash costs rose to $1.85 per pound vs. $1.57 per pound in 1Q13.
Lower output from the company's Indonesian operations pushed up copper unit cash costs, which rose 24% to $1.85 per pound in the quarter. With production back online at Grasberg, the company now expects 2013 cash costs to average $1.58 per pound.
Gold sales of 173,000 ounces were down 41,000 ounces Q/Q. At the same time, gold realized price dropped to $1,322 per ounce from 1,606 per ounce in 1Q13.
The company also reported 1 month results of the newly acquired energy segment. Freeport reported energy sales of 5 MMBOE with realized price of 74.37 per MMBOE and cash margin of $57.79. Due to the timing of the transaction close only 1 month results were reported.
Overall, Q2 was a messy quarter, but this was to be expected on account of the Grasberg mine accident and PXP/MMR integration.
Due to the temporary production suspension at Grasberg in 2Q13, the company has lowered its consolidated sales volume expectations for copper and gold to 4.1 billion pounds and 1.1 million ounces respectively from previously reported targets of 4.3 billion pounds and 1.4 million ounces. The company also provided sales guidance of 35 MMBOE for the newly acquired energy segment.
Freeport also lowered its capital expenditure for 2013 to $5.5 billion. The company sliced $1.9 billion off its 2013 and 2014 capital spending and other costs, including $1.0 billion off of mining capital spending projects, $0.4 billion in reduced oil and gas investments, and $0.5 billion in reduced exploration spending.
Financials and Valuations
FCX's attractive valuations also make a good case for investment in this mining and energy company. The company is trading at a discount to its historical 5 years average, industry average, and S&P 500 price-to-earnings (P/E) ratio. It has a current P/E ratio of 9.5 compared to the industry average of 11.0 and its own 5 years average of 11.5. S&P 500 has a P/E ratio of 16.6. FCX has forward P/E of 9.0, compared to 14.7 of S&P 500.
The company has price-to-book ratio of 1.5 compared to the industry average of 2.2 and FCX's own 5 years average of 3.7. It has price-to-sales ratio of 1.5 compared to the historical average of 1.9 and industry average of 2.1. Finally, FCX has a price-to-cash flow ratio of 7.3 compared to the industry average of .91 and company's 3 years average of 7.7.
In comparison Southern Copper (SCCO) has a current price-to-earnings ratio of 13.4 and a forward P/E of 16.6. SCCO has price-to-book ratio of 4.8, price-to-sales ratio of 3.7, and finally price-to-cash flow ratio of 12.9.
Freeport also has a very attractive forward annual dividend yield of 4.4%.
Conclusion and Investment Thesis
We have a buy rating on Freeport. We believe FCX shares represent the most compelling long-term investment opportunity within the U.S. metals and mining sector. While the announcement of the company's acquisitions of PXP and MMR last December came as a surprise to most and our own initial reaction to the news was negative, we believe it's time for investors to move on and revisit the 'new' FCX that it is today.
Going forward, we believe FCX represents a good investment opportunity for both short and long-term investors. The company has an attractive, high quality asset base. It remains one of the premier natural resources companies in the world and an undervalued copper play. The acquisitions of PXP and MMR provide investors diversification with attractive oil and gas assets. Freeport is also trading at very attractive valuations and represents a good entry point for investors. The company is also well positioned to benefit from its strong projects pipeline.
The Grasberg incident which claimed 28 lives, while clearly tragic, would have limited impact on Freeport's performance. The production disruption was temporary, meaning there is no impairment of future production. There is no material impact on total future cash flows either; the cash flows are only deferred.
Have a good day!