In 2013, shares of Freeport-McMoRan (FCX) have treaded water, though they have rallied nicely from their summer low of $27 (see chart below). While shares haven't moved much, 2013 has been an eventful year from the company. There was a tragic, fatal accident at the Grasberg mine, which also resulted in reduced output from the facility while the company investigated the incident to ensure that there would be no such tragedies in the future. On the positive side, FCX reinvented itself this year with aggressive acquisitions in the oil exploration sector, which should prove cash accretive in 2014 and smooth out some of the volatility in the company's cash flow.
If 2013 was the year Freeport built a company that can thrive in the long run, 2014 will be the year we slowly start to see dividends from the company's diversification while 2015 and 2016 will show the true potential of the company. 2014 will be a strong year, but one that also focuses on right-sizing the balance sheet and normalizing production to set up for future growth. Historically, Freeport-McMoRan was centered on cooper and gold. In 2014, the company should generate $6.5-$7.0 billion in operating cash flows, and $2.75-$3 billion of that sum will come from its new oil and gas unit. In one fell swoop, FCX has gone from being a premier mining company to a premier commodity company that can invest in its various units based upon the attractiveness of their respective markets.
FCX also has the flexibility to head off any declines in commodity prices in 2014. The company has a put portfolio, which will negate much of the negative impact of a down year in the Brent crude market. The company also has best in class cash costs. Copper cash costs are $1.46, down 10% year over year and less than 50% of the market price. This drop came despite the fact that by-products (namely gold) had a lower selling price. In 2014, I am looking for cash costs to improve slightly to the $1.40-$1.46 range. Its oil unit has exceptionally strong cash margins with cash costs of $16.80 per barrel, only 20% of the company's selling price. As a consequence, FCX oil and gas will be cash self-sufficient in 2014 as it continues to expand its drilling activities.
In 2014, I am looking for continued capital efficiency as FCX begins to work down its $21 billion in debt due to the oil acquisitions. As the company cuts its debt, it is working to cut $1.9 billion in capital expenditure, and I am looking for cap-ex of $4.5 billion in 2015, giving the company $2.5 billion in free cash flow, allowing management to comfortably cover the dividend and pay down $1-1.5 billion in debt with an accelerated pay down in 2015 of upwards of $3 billion.
Obviously, copper remains a critical piece of FCX's business, and I am optimistic about its future and expect it to hold above $3.00 in 2014 and average roughly $3.25. China is revamping its electric grid, which should provide near term support for the commodity while improving U.S. construction spending will also help prices. Over the long run, the fundamentals of the copper market are strong. The emerging world will be dramatically improving its infrastructure to support economic growth, and copper is a critical component of all infrastructure projects. Even parts of the developed world, particularly the United States, need major infrastructure updates. In the immediate term, the age of austerity will postpone upgrades, but at some point, they become essential. In fact, McKinsey estimates $57 trillion will need to be spent on infrastructure by 2030, up 60% from the infrastructure spend of the last 18 years. It is fashionable for market commentators to say copper is doomed as China slows down, but we are just at the tip of the iceberg when it comes to copper. Infrastructure needs are growing not shrinking, and as the world builds more homes, roads, trains, and power capacity, copper will continue to be mined and used profusely. By 2016, I would look for copper prices back above $4.00, giving Freeport tremendous profit potential.
In 2014, I am looking for FCX to grow production by 2-3% and get end prices of $3.25/lb for copper, $1,200 for gold, and $80-$82.50 per barrel of oil equivalent, which should generate EPS of $3.50, operating cash flow of $7 billion, free cash flow of $2.5 billion, a flat quarterly dividend of $0.3125 (3.65% yield), and a debt pay down of $1-$1.5 billion. Right now, FCX is trading at less than 10x earnings, which is extremely cheap as profits are poised to flex dramatically higher as pricing power improves in 2015 thanks to the company's exceptionally low cash costs. I would be an aggressive buyer of FCX at current levels and would pay at least 13x earnings, which suggests a fair price of at least $45.