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Phelps Dodge (PD)

Q4 2006 Earnings Call

January 29, 2007 9:30 am ET

Executives

Steve Whisler – Chairman, CEO

Tim Snider – President, COO

Rami Peru – EVP, CFO

Steve Higgins - President, Phelps Dodge Sales Co.

Stan Rideout – VP, Treasurer

Analysts

John Hill – Citigroup

Presentation

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Phelps Dodge Analysts' Conference Call. (Operator Instructions) I would now like to turn the conference over to Mr. Stan Rideout, Vice President and Treasurer at Phelps Dodge Corporation. Please go ahead.

Stan Rideout

Good morning to everyone on today's call. This event is being webcast and therefore the audio is available to both media and the general public. The webcast can be accessed at www.phelpsdodge.com.

The webcast may contain forward-looking statements as defined in section 27-A of The Securities Act of 1933 and section 21-E of The Securities Act of 1934, including statements regarding among other things, the company's business strategy and growth strategy.

All statements other than historical information are forward-looking statements. These forward-looking statements are based on management's current expectations, speak only as of today's date and are subject to a number of risks and uncertainties which cannot be predicted or quantified and are beyond our control. Future developments and actual results could differ materially from those set forth in, contemplated by, or underlying the forward-looking statements. Please refer to the Risk Factors section and Management's Discussion and Analysis section of our recent 10-K and 10-Q reports, as well as our publicly available filings with the Securities and Exchange Commission for a discussion of factors that could cause such actual results to differ materially.

In addition, this webcast may contain forward-looking statements concerning the proposed merger of Phelps Dodge with Freeport-McMoRan Copper & Gold Inc. Please refer to the risk factors and cautionary statements regarding forward-looking statements included in the preliminary joint proxy statement/prospectus filed by Freeport with the SEC for a discussion of factors that could cause actual results of the proposed merger to differ materially from such forward-looking statements.

Phelps Dodge urges investors and stockholders to read the definitive joint proxy statement prospectus when it becomes available and any other relevant documents filed by either party with the SEC, because they will contain important information. Phelps Dodge and certain of its directors and executive officers may be deemed to be participants in the solicitation of proxies from its shareholders in connection with the merger. Information concerning the interest of Phelps Dodge's directors and executive officers in Phelps Dodge is set forth in the preliminary joint proxy statement/prospectus filed with the SEC.

This webcast does not constitute an offer to sell, nor the solicitation of an offer to purchase, any securities nor solicitation of a proxy, content, authorization or agent designation with respect to a meeting of the company's stockholders.

During today's call there may be terms used to describe supplemental data. Any such data or terms are not a substitute for any U.S. GAAP measure and should be evaluated within the context of our U.S. GAAP results. Also, any such references may not be comparable to similarly titled measures reported by other companies. Please refer to our press release at our website at www.phelpsdodge.com.

This event is being recorded by Phelps Dodge and is copyrighted material. It cannot be recorded or rebroadcast without express permission. Your participation implies consent of these terms. Please drop off the line or terminate your connection if you do not agree with these terms. The replay of the webcast will be available on the Phelps Dodge website today beginning at approximately 2:00 pm Eastern through February 5th.

With that I will turn the meeting over to the company's Chairman and Chief Executive Officer, Steve Whisler.

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Steve Whisler

Thank you, Stan and good morning and welcome to everyone on our call. With me today in Phoenix are Tim Snider, our President and Chief Operating Officer; Rami Peru, Executive Vice President and Chief Financial Officer; and Steve Higgins, the President of our sales company.

Our format this morning will be as follows: I am going to briefly review our fourth quarter and full year 2006 results, and then I am going to ask Steve to comment on the copper and moly markets. I'll come back and provide a brief update in terms of the status of the Freeport transaction, and as a result of that transaction, I will provide the first quarter guidance that we are contemplating; and then, we will be pleased to take your questions.

Turning to our fourth quarter results, we delivered record net income in the fourth quarter, despite a decline in copper prices compared with the two previous quarters. Now having said that, the average copper price for the quarter was still a very robust $3.20 per pound. We reported record GAAP earnings of $1.32 billion, or $6.50 per share, for the quarter. That exceeded the high end of our $4.75 to $5.50 per share of guidance. Included in that number were $0.77 per share for mark-to-market gains on the copper collars as a result of the copper price falling there at year end; also included was a $1.79 per share from special items, primarily the following: $1.32 per share associated with the remaining portion of the eco breakup fee, net of taxes and expenses; and $0.63 per share for the reversal of the U.S. deferred tax asset valuation allowance.

For the year of 2006, we recorded record net income of a little over $3 billion -- actually $3.018 billion -- or $14.83 per common share, which is our third consecutive year of record annual net income.

PD mine production was 609 million pounds, and that was below the low end of our guidance range, primarily due to lower than planned production from the Cerro Verde sulfide start up, and to a few small shortfalls in our North American operations, none of which was significant individually. The Cerro Verde start up is coming along nicely. The shortfall in the quarter was simply a matter of aggressive forecasting on our part. Just to remind everyone, we have publicly stated that we had expected to have the first half of the plant commissioned by year end 2006 and the second half up and running by the end of June 2007. Construction of the project has, in fact, gone very well and we believed that we could pull the second half of the plant forward quite a bit and that was the basis for our fourth quarter guidance and forecast. We are currently running at about 75% of designed capacity, but are still working out the kinks of that operation. So to summarize, we are well ahead of our original schedule, but we came up a little short on our admittedly very optimistic commissioning plan.

I think the best news of all, from my perspective, is we appear to be over our original capital budget of $850 million by less than 5%. Given the high double-digit and sometimes triple-digit increases many other large capital projects have experienced, I think this is an impressive outcome and it has been driven by our engineering and operating management.

As a result of our lower production, sales of PD mined copper were 599 million pounds, which again was slightly below the low end of our guidance range.

Fourth quarter cash flow from operating activities of $1.75 billion was above our guidance of $1.5 billion, due in part to favorable timing of working capital items. The timing of payments for capital spending, primarily for the Safford project and mining equipment at some of our North American operations, resulted in lower than planned fourth quarter capital spending of approximately $360 million, which was just about $129 million, $130 million of which was tied up in accounts payable and not included in that quarterly capital figure.

At quarter end, cash on hand was just under $5 billion, approximately $3.9 billion of that was held in the United States with the remaining $1.1 billion held internationally, and about $500 million of that is held for minority interests.

That concludes my brief overview of our fourth quarter results. By and large, a very straightforward and outstanding quarter from my perspective. Clearly one of the interesting things going on right now is what's going on with the markets, and I'm going to ask Steve to comment on both the copper and molybdenum markets.

Steve Higgins

Thank you, Steve and good morning. Quite simply 2006 was an extraordinary year to be in the copper business. The price averaged $3.09 a pound for the year, up nearly 85% from 2005 average of $1.68. Historically low refined copper inventories, significant production disruptions and increased fund activity contributed to the unprecedented price levels.

Overall, we believe that the refined copper market was roughly in balance during 2006, however, developed quite differently than most observers had expected. Labor disputes, mechanical failures, and ore grade issues combined to reduce global mine output from expectations by some 600,000 to 700,000 metric tons. Refined production ended up around 5% from 2005 levels.

The year was characterized by strong first half growth in global refined consumption followed by a more modest second half. We estimate copper consumption for the full year increase by 4%. At the regional level, however, there were some notable events.

In the U.S., the first half of 2006 started well with refined consumption increasing from a year earlier. However, consumption in the second half and particularly in the fourth quarter, declined due to flagging demand from residential construction, a reduction in auto and light truck builds, and a significant downstream inventory liquidation across all consuming sectors.

Our current estimate is that U.S. refined copper consumption decreased between 3% and 4% during 2006. In China, we believe refined copper consumption increased by 5% after taking into account the drawdown in SRB and consumer inventories. Europe experienced strong growth in copper consumption, increasing between 7% and 8% for the year, and Japan’s refined consumption also rebounded from 2005, ending the year up around 5%.

As we look at 2007, we believe that the market fundamentals will continue to be favorable for copper. While they grew at year end, both exchange and off-exchange inventories are very low by historical standards. For 2007, we expect world copper consumption to increase 3.5% as a result of continued global economic growth.

In the U.S., we anticipate that industrial production will grow between 2% and 3% for the year, and while we do not expect a sharp turnaround in construction activity or automotive production, we agree with most analysts that the worst of the current correction is behind us. While residential construction has suffered, non-residential construction spending increased around 14% in 2006 and will likely continue to grow this year. As a result, we expect U.S. copper consumption to increase 1%.

In China, we expect that industrial production will expand at 15% year over year. We believe that destocking of 2006 has run its course, and expect to see stronger demand in 2007. We anticipate China’s refined copper consumption will grow at 7% or higher this year.

Following a year of strong growth, we anticipate both Europe and Japan’s copper consumption will increase by approximately 1% in 2007.

On the production side, we expect refined output will grow approximately 5% year over year, and overall we expect the market to move towards a modest surplus. However, if we continue to see disruptions at levels similar to last two years, than the market would be closer to balanced, likely putting upward pressure on the price.

That concludes my comments on copper; now I will turn to the moly market.

With the industry essentially in balance, moly prices strayed in a range between $21 and $28 per pound, and averaging $24.75 to the year. The price was lower than the 2005 average, but for the third consecutive year, molybdenum prices remained at historically high levels.

Consumption of molybdenum was better than expected in 2006 with global growth of 6% year over year, thanks to continued strong demand of both metallurgical and chemical segments. North American metallurgical demand did weaken somewhat in the fourth quarter, mainly due to the downturn in automotive builds.

However, demand in other regions, in particular China, remained strong throughout the period. Supply of moly remained at approximately 2005 levels as increases in primary mine production were offset by decreases in byproduct mine production. Reduction from mines in China did increase during the period but the absolute level remains difficult to estimate. 2006 supply was further supplemented by a drawdown in concentrate inventory as roaster constraints were largely eliminated.

Turning to 2007, we expect consumption growth to remain healthy but to grow at a slightly lower rate of between 4% and 5%. Regulatory requirements for low sulfur diesel fuel remain the primary driver for chemical market growth, while metallurgical demand continues to be driven by strong global growth in nearly all stainless steel end use sectors, in particular oil and gas, aircraft and construction.

On the production side, we're looking for growth of just over 5% year over year, based on new byproduct mines reaching full production levels in 2007 and an increase in supply from Chinese mines. However, there continues to be uncertainty regarding the sustainability of high-grade byproduct production at existing mines. Overall, we expect the market to be near balanced to perhaps a modest surplus by year’s end. Inventories while growing, will remain well below normal levels. As a result, we believe prices will moderate somewhat from 2006 levels but remain, again, historically high.

That concludes my comments and I will now turn the call back to Steve.

Steve Whisler

Thank you, Steve. Let me just provide a quick update on the transaction that we announced during the fourth quarter with Freeport Copper & Gold. The reasons and rationale for that transaction are set forth in a great amount of detail in the preliminary proxy materials that Stan referenced in his opening comments, so I don’t intend to repeat any of that here. I am just going to simply try to provide an update in terms of where we stand.

I think from our perspective, we remain on track to complete that transaction by the end of the current quarter. Freeport is working with the SEC on those preliminary proxy materials, and hopefully we will be in a position to have that move forward here shortly.

The transaction is subject to shareholder and regulatory approvals, which are progressing. The U.S. antitrust authorities did grant early termination of the waiting period under the HartScottRodino Act in late September of last year. We are working to obtain EU and other regulatory approvals, and I am not aware of any issues in that regard.

The shareholder meetings will be scheduled once the SEC declares the proxy effective and we expect those meetings to be held, as I said, in March with closing thereafter.

Given the fact that we expect that transaction with Freeport to close by the end of this quarter, we are going to limit our guidance for the first quarter to the following Phelps Dodge metrics: these numbers should enable you to do the necessary modeling as you combine the two companies and look forward on a prospective basis. Obviously, going forward you can make adjustments as you see fit.

For Phelps Dodge, copper production for the first quarter of this year should be in the range of 600 million to 655 million pounds, and it should approximate 2.9 million pounds for the year. Copper sales in the same period – that is, the first quarter – should be in the range of 615 million to 645 million pounds, and again, for the year, should also approximate 2.9 million pounds. Finally, cash on hand at the end of the first quarter will likely approximate $4.6 billion, of which approximately $2 billion will be held outside of the U.S. and that amount will include approximately $700 million held for the account of our minority partners.

With that, that concludes our formal remarks and overview of the quarter. As I said, all in all, a fairly uneventful quarter and one which our guys did a great job of delivering from an operational standpoint. With that, operator, we will open up the lines for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from John Hill – Citigroup.

John Hill – Citigroup

Thank you and good morning, everyone. I was just wondering if we could have a comment or two on anything new we are seeing on the subject of copper substitution?

Steve Higgins

Thank you, John. I don’t think that we have seen anything new on substitution as compared to what we have commented in the past. The early substitution that we saw in those product areas that can move easily between copper and aluminum or other products took place pretty early on in the cycle.

The concern, of course, is the longer the price stayed high the more we would see the potential for re-engineering products into other materials. In fact, we have seen very limited amounts of that, and I think primarily as a function of the fact that it is very difficult for other materials to duplicate copper’s characteristics. Manufacturers are going to do that very carefully, and only, I think, if they think that the price differential is going to remain high for the long term.

So while there has been bits and pieces here and there, and certainly the plumbing tube market is probably the most notable, we’ve seen fairly limited further substitution since our last call.

John Hill – Citigroup

Very good. And then just a quick follow-up if I could on concentrate leach. Anything new to report from Morenci and then any further thoughts how that might translate into opportunities elsewhere in the industry?

Tim Snider

John, this is Tim Snider. Morenci straight leach project is going along well. We expect it to start up sometime in the middle of the year, and we are pretty confident about how that is going to go. We are continually studying where that might go in the future, but we are pretty optimistic.

John Hill – Citigroup

Great, thank you.

Steve Whisler

Okay, I guess that is the only question that we had, so – are we getting one more?

Operator

(Operator Instructions)

Steve Whisler

All right, well we have no questions so I guess we are getting a free pass, a little bit. Let me close with the following comments, if I may. I recognize that this could be Phelps Dodge’s final earnings conference call, and if everything goes according to plan our agreement to be acquired by Freeport-McMoRan will be completed before the end of March.

For that reason and on behalf of the board of management, I would like to take this opportunity to thank a number of people who have supported Phelps Dodge over the years. Our customers have continued to support us with their business; our suppliers have provided us with excellent products and services; and our engineering and construction contractors have helped us develop efficient, effective projects.

But above all, I want to thank our employees whose dedication and hard work have helped us achieve record results for three consecutive years. I especially appreciate their unrelenting focus on safety, as they constantly strive to achieve the goal of zero injuries and occupational illnesses. Employees have been instrumental in achieving our advanced growth projects, such as the new Safford mine and the Tenke Fungurume project in the Democratic Republic of the Congo. They have also played a key role in ensuring that we protect the environment and address our legacy environmental issues to address reclamation and remediation.

For nearly 173 years, the Phelps Dodge name has been a part of the American and global landscape, and I am pleased Freeport-McMoRan will keep it alive in the marketplace. We all look forward to making significant contributions to the exciting new company we will become in combination with Freeport-McMoRan.

So again, on behalf of the board and management, I thank all of you. Operator, thank you very much.

Operator

Ladies and gentlemen, that concludes our conference for today.

TRANSCRIPT SPONSOR

HIHO logo

Did you know?

MOLYBDENUM PRICES HAVE SKYROCKETED OVER 500% IN THE LAST 5 YEARS.

Industry experts anticipate Molybdenum price increases to continue well into the future.

Enter- HI HO SILVER RESOURCES INC.

Preliminary drilling indicates the Kettle River Property holds a gross metal value of

$1.5 BILLION USD. Past work indicates good potential for discovering additional molybdenum mineralization within the property.

For more information on our company, please visit our website.

Hi Ho Silver Resources trades under symbol HIHO.

To sponsor a Seeking Alpha transcript click here.

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Source: Phelps Dodge Q4 2006 Earnings Call Transcript
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