Freeport-McMoRan's Problems Could Put This Stock In Play

| About: Freeport-McMoRan Inc. (FCX)


Freeport-McMoRan's problems give us an opportunity to buy at a depressed price.

Reservoir made one of best copper discoveries ever.

A strong balance sheet puts the junior in control of its destiny.

Even in a depressed industry, there can be opportunities. Copper is certainly depressed, yet a low-priced company that makes a once-in-a-decade discovery can still offer opportunities for profit, especially when it has two global giants as partners.

Copper may not be the most loved commodity right now. We can debate the fundamentals - slowing manufacturing in China, yet low inventories - but the current price, as Freeport-McMoRan's (NYSEARCA:FXC) Richard Adkerson said, "is what it is". Looking ahead, however, there is a paucity of major projects likely to come on-line anytime soon. And major deposits are few and far between, in any event.

That makes a large, high-grade deposit attractive for major mining companies in any environment. Reservoir Minerals (OTCPK:RVRLF, TSX:RMC), a Canadian junior, is 45% owner of the Cukaru Peki copper deposit in Serbia, part of a larger Timok project. Freeport is currently earning in the project, and can earn up to 75% by taking it through the feasibility study. Uncertainty around whether Freeport will complete is one of the reasons that Reservoir is so inexpensive right now, severely undervaluing its interest in this world-class discovery. More on that below.

An exciting discovery

Cukaru Peki is a high-sulphidation epithermal deposit on top of a large copper-gold porphyry. It has similarities to the historic Bor mine, about 3.3 miles to the north. The deposit is high-grade, with consistent mineralization, grading 2.6% copper and 1.5 g/t gold, with some extremely high intersections (including 9.6% copper and 5/9 g/t gold). Indeed, more than one exploration geologist told me that the initial discovery hole was among the best holes in any metal that he had ever seen. So high-grade is the deposit that it would be economic even at $1/lb copper, according to recent company presentations. (Copper is currently trading around $2 per pound.)

Even at current copper prices, the deposit has a present value of over $1 billion, with a 20-year mine life, according to various analyst models. (More in-fill drilling is required before there is a 43-101 compliant reserve.) The deposit is open in all directions, including at depth. The size of the underlying porphyry has not yet been delineated. Given the high-grade nature of the deposit, it could be in production as soon as 2019 (though we think it will be later). This deposit alone gives a discounted net asset value to Reservoir of nearly C$9 - well over double its current trading price.

In addition, Reservoir has a broad portfolio of exploration projects in Eastern Europe, including another joint venture with Rio Tinto (NYSE:RIO), some prospective 100%-owned properties along the same trend, plus some gold projects in West Africa. The venture with Rio, another major global mining company with experience in block caving production as well as experience in Serbia, was completed just last month; it certainly adds some value to the company. Reservoir is well funded, with $33 million and a low burn rate.

Serbia is an attractive mining jurisdiction with a long history and skilled workforce. There is no limit on foreign ownership, and no government participation. There are some work requirements to keep permits active, however. The area around Timok has very good infrastructure because of the nearby Bor mine, producing for over a century. This includes electricity, water, rail, even a smelter. Electricity and labour are both quite inexpensive.

Freeport has been active

Given Freeport-McMoRan's current financial difficulties, there is justifiable concern about the company's future in the joint venture. We should note that although Freeport dropped most of its global exploration projects last year, it kept this one, and that it has been aggressive in drilling in recent months (with 14 rigs on site right now). Last year's budget was $18.7 million - quite a healthy spend in the current environment. This included in-fill drilling as well as various step-outs to test other targets. Nonetheless, the company has said that all mines and projects are potentially for sale, and despite extremely favorable comments made by Freeport personnel, right up to the top, over the past year, the interest in the Timok Joint Venture (it has already earned 55%) will likely be sold. No budget for 2016 has yet been presented to its partner. It is clear that until recently, Freeport wanted and intended to stay in this, its highest-profile exploration project. More recently, perhaps it simply want to complete the 2015 budget, spending the funds to meet government obligations and make its interest more attractive to sell.

Reservoir has a right of first offer on the joint venture property, so any company interested would have to work with Reservoir.

Only a handful of mining companies would be in a position to take on the project, and many are themselves looking to sell assets. But world-class discoveries like Cukaru Peki do not come along very often, so we suspect someone else will take it over in the next few months. Freeport cannot afford to sit on it and do nothing, in view of the government-mandated development timelines. It must deliver a bankable feasibility study by the first quarter of 2019. Given the amount of work that would be required for such a study, work would have to commence fairly soon. A Preliminary Economic Assessment is anticipated by the middle of this year.

Possible outcomes

The major risk for Reservoir is that it is not in the driver's seat. It has a free carry until the feasibility study is delivered, but equally, no claim on Freeport until then. It has tried to offset this risk by bringing in another major company on another of its properties, and by putting itself in a strong position to negotiate with Freeport for possible return of the project. Freeport could also decide to keep its 55% interest, reducing its expenditures. In addition to being strong technically, the Reservoir management team has also demonstrated skill at positioning itself vis-à-vis its bigger partner.

The stock is tightly held, since the shares are controlled by a handful of major holders who seem to want to hold on until the end game. Major shareholders include BlackRock, J.P. Morgan, and a Chinese copper smelter. The current level is a good price to buy, giving a potential return of 150% over a reasonably short period. I prefer to buy Reservoir on the Toronto exchange, where liquidity is better than on the OTC.

Clients of Adrian Day Asset Management own over 5% of the shares of Reservoir Minerals.

Disclosure: I am/we are long RMC ON TORONTO.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.