Copper producers were largely affected by the decline in the commodity prices in fiscal year 2013. However, the good news is that commodity prices will not decline further in fiscal year 2014. In order to remain competitive and post decent margins in the future, the commodity producers will either have to cut down their costs or diversify their portfolio. There are very few companies in the copper industry that are able to post decent margins despite such turmoil. Freeport-McMoRan Copper & Gold Inc. (FCX) is one of those few companies operating in the copper industry under such circumstances. Let us analyze the company's future prospects and historical results in order to identify the investment opportunity.
Before analyzing the company's long-term policies I would like to analyze the company's past performance with respect to industry.
Positive Company History
The overall copper industry has gone through tough times therefore, recently, the industry's margins have been drastically suppressed. However, despite such turmoil, Freeport has successfully reported better results than its peers in the industry. Its gross margin, operating margin and net margin are all higher than that of the industry average. The company's gross margin is 29.69 percent which is well above the industry average of 19.27 percent. The operating margin of the company is almost double the industry's operating margin. The effect of higher gross margins and operating margin also trickled down to the bottom line of the company. Moreover, another catalyst for investors is the fact that the company has a dividend yield of 3.58 percent which is quite higher than that of the industry average of 2.67 percent.
Now let's analyze the company's future prospects.
In order to cater to the low-pricing environment the company is diversifying its portfolio by increasing its share in oil & gas segment. Not only is the company gaining more exposure in the oil & gas industry but also reducing its capital expenditures in mining projects as the commodity prices are very much depressed.
As shown in the following graph, the company is expecting a capital expenditure of $5.5 billion in fiscal year 2013 while these expenditures are expected to remain at $6.7 billion in fiscal year 2014 as well as 2015. However, the key thing to focus on is the fact that the company's capital expenditure in the oil & gas segment is expected to rise from $1.5 billion to $2.7 billion in fiscal 2014 and then $2.9 billion in fiscal year 2015. On the other side, capital expenditures in total mining will decline from $4 billion to $3.8 billion from fiscal year 2013 to fiscal year 2015. Such a huge increase in capital expenditure in the oil & gas segment indicates that the company wants to diversify its portfolio by investing in oil & gas in order to cater to the low-commodity-pricing environment.
SOURCE: Company's Presentation
The company has total reserves of oil & gas of 688 mmboe while its production is 177 mboe/d. Moreover, the company's production of oil & gas is expected to be double over the next five years. Therefore, I believe that the oil & gas segment's contribution in net profit of the company will rise in the future. As shown in the following graph, oil & gas will contribute 27 percent to the EBITDA of fiscal year 2014.
SOURCE: Company's Presentation
Strong Free Cash Flows
It seems to be a positive fact that the company is diversifying its portfolio. However, I wonder whether or not the company would have to issue more debt to finance these projects or if it will be able to generate enough cash flows to fund these projects. Assuming a copper price of $3/lb, gold price of $1300/oz, molybdenum price of $10 and oil price of $100/barrel total operating cash flows will be $8 billion in fiscal years 2014 and 2015, while these cash flows will increase to $12 billion in fiscal year 2016. However, these are very prudent estimates of operating cash flows, in my opinion. This increase represents an increase in the production of copper, gold and oil & gas over the next few years. Therefore, I believe that the company will generate enough operating cash flows that will help it to fund these projects in the future.
According to the company's estimates, "For 2014e/2015e average, each $50/oz change in gold approximates $45 million to operating cash flow; each $1.00/lb change in molybdenum approximates $65 million to operating cash flow; each $5.00/bbl increase in oil approximates $140 million to operating cash flow". Therefore, I believe that a slight increase in any of these commodity prices could have a significant effect on the operating cash flows of the company.
However, at the same time, the company will have to pay off its debt obligations. Moreover, the company also pays dividends to its shareholders. The company's current level of debt is $20.4 billion, which the company aims to decrease to $12 billion over the next three years (by the end of 2016). I believe that the company will have enough cash flow to not only pay its obligations but to also share its success with its shareholders by paying high dividends in the future. The following table shows the projected capital expenditures, operating cash flows and debt payments.
I have made an assumption in the following table that the company's capital expenditure will not change in fiscal year 2016 but will remain at $6.7 billion. Another key assumption is with regards to debt maturities and the company's discretion to pay off its debt. The company has a total debt maturity of $1.987 billion in fiscal years 2014 and 2015. I have assumed that the company will pay off half of this $1.987 billion debt during each fiscal year (2014 and 2015). Moreover, the company has a debt obligation of $1.372 billion in fiscal years 2016 and 2017. The company stated that it will decrease its total debt to $12 billion over the next three years therefore I have assumed that in order to pay off its $8.4 billion debt the company will pay $6.41 billion of debt in fiscal year 2016.
Note: (Cash balance for fiscal 2013 is calculated by assuming the debt payment of $67 million, with operating cash flows of $6 billion, capital expenditure of $5.5 billion and cash balance in the most recent quarter of 2.22 billion.)
Another key measure to determine the company's ability to meet its obligations is an interest coverage ratio. The company has an interest coverage ratio of 27.65 times which is much higher than the industry average of 13.82 times. Therefore I do not believe that investors should worry about the company's ability to pay off its obligations.
I also do not believe that investors should be worried about their dividends or returns from the stock in the future because not only is the company reducing its risk by diversifying its portfolio but it will also be able to generate enough cash flows in the future to achieve its long term goals.
Not only did the company outperform its peers in the industry but I also believe that it will continue to outperform the industry in the years to come. In order to cater to the problem of low copper prices the company is diversifying its portfolio by investing in its oil & gas segment. Therefore, I believe that the company will be able to perform better than its peers in the copper industry owing to its more diversified portfolio. Thus, I would recommend investors buy the stock.