It was this month last year when Freeport-McMoRan Copper & Gold (NYSE:FCX) announced its controversial decision to acquire Plains Exploration & Production Company (NYSE:PXP), shale and gulf oil player, and McMoRan Exploration Co. (NYSE:MMR), a deep sea drilling company. We have long been saying that FCX has emerged as one of the most underappreciated and undervalued long-term growth stock in the mining and energy sectors from this surprised acquisitions.
FCX has a strong pipeline of mining and energy projects. It has the potential to generate substantial annual EBITDA growth for many years, which should result in meaningful FCF generation, debt reduction, and multiple compression (Barclays estimates FCX to generate more than 10% annual EBITDA growth for the next seven years).
There is a significant volume growth across FCX's portfolio of assets and the company's shares should benefit from it. Over the next three years, as the company's copper related capital spending turns to energy related capital spending, the company is set to grow oil equivalent volumes by 178%, gold by 90%, and copper by 32% (Barclays report 10-Dec). Most of the expansion projects are in advanced stages and have good line of sight. Additionally, over the next five years the company is targeting to double its oil and gas output.
FCX has also recently indicated that it may consider, among other options, an MLP like structure for some of its onshore energy assets to unlock value. For FCX's shareholders this could potentially unlock further value in the next few quarters. Two groups of assets that FCX could use in an MLP structure include California energy assets and Arizona copper assets. Development plans at the California energy assets are focused on maintaining stable production levels in established producing fields principally onshore in California. Given their slow depletion, stable production, and strong margins and cash flows, California energy assets provide a viable MLP structure. On the other hand, Freeport's GoM Deep-water assets would not appear attractive to MLP investors. They deplete quickly and the cost to maintain reserves and production in this region is high.
Arizona copper assets (Bagdad and Morenci) also have MLP like characteristics. Based on 2012 production rate, Morenci has 14.8 billion pounds of recoverable reserves and 28 years of production. While Bagdad 8.2 billion pounds of recoverable reserves and 42 years of production.
Focus On De-leveraging
Freeport took on a substantial debt for the acquisition of PXP and MMR, increasing its net debt from $0.5 billion in 1Q13 to $18.9 billion in 3Q13. Going forward, the company has set a target of reducing its total debt from $21 billion (current) to $12 billion over the next three years. While FCX expects to be able to fund debt reduction largely through operating cash flows, it continues to analyze options for divestitures and possible monetization of assets to speed up debt reduction. Freeport is highly committed on this goal and has indicated a review of divestitures is ongoing and that the company is prepared to respond to varying market conditions and achieve its goal of reducing its debt.
We have a buy rating on FCX. FCX is still trading at a discount to its peers due to various concerns about Grasberg. However, Grasberg ramp-up next year and the company's ability to export concentrate should reduce concerns and close the gap. Freeport's strong pipeline of growth projects will provide the company with significant capacity in coming years. Moreover, since they are all brownfield projects, they have relatively low capital costs and risk.
Most of the company's expansion projects are also in the advanced stages and have a good line of sight. In the next five years, the company expects to double its oil and gas output. Moreover, in the U.S near Freeport's existing operations, there is a significant portion of mineralized material for copper that has yet to be cleared as official reserves is. It gives Freeport the option of expanding its U.S. assets at a time when the U.S. has become a strong place to develop operations, especially with low energy costs.
Higher grades at Grasberg could also help FCX beat production and sales guidance. Over the past couple of years, Freeport has been in a lower grade area of its Grasberg mine; however, beginning in 3Q13, reached a higher grade area. Going forward, as the company ramps up volumes, higher than expected volumes are possible and the costs should come down.
FCX's attractive valuations and forward annual dividend yield of 3.6% also make a compelling case for investment in this Phoenix, Arizona based company. Freeport shares have further upside potential from current levels, as the company executes on its deleveraging goals, production growth plan, and value-enhancing MLP opportunities in the energy and copper businesses.
For more information on FCX please go here.