Is It Getting Better For Freeport-McMoRan?

| About: Freeport-McMoRan Inc. (FCX)

Summary

Freeport-McMoRan got a boost from the recent rally of copper prices.

But has the copper market improved?

FCX is making changes to improve its balance sheet and cash flow, but the risk remains high.

Freeport-McMoRan Copper & Gold (NYSE:FCX) has received a boost from the recent recovery of commodities prices mainly copper and precious metals. But the latest spike in shares in Freeport may not last long especially considering the fundamentals in the copper market suggest the latest rally will be short lived. If so, FCX is prone to change course and fall. The company, however, is slowly adjusting to the soft commodities markets and slowly climbs back up from its dire situation.

The copper rally - what's behind it?

For FCX, copper remains the main source of income as it accounts for over 60% of its revenue (as of 2015). Therefore, the recent bounce in the price of copper -- prices rose from less than $1.9 per pound to close to $2.3 or over a 20% jump within a matter of weeks -- contributed to the rally of FCX. Despite this recovery, even Freeport officials aren't too optimistic about the copper market and think that only by 2017 the demand will catch up with production. So what could explain the recent bounce back in the price of copper?

Several factors could have contributed including: China's growing imports for the base metal, the publication of China's five year plan that includes maintaining a growth rate of 6.5%-7% per annum, the devaluation of U.S. dollar, and the fact that the anxiety in the markets over a possible global slowdown has subsided, for now. Let's consider two specific issues: China's growing imports and the weaker U.S. dollar.

China remains the biggest copper consumer and major importer. And even though the copper market isn't doing well, or perhaps because of it, China has ramped up its imports - according to one source China's imports in January-February rose by 55%, year on year. And in February alone imports spiked by 92% compared to February 2015. But the higher imports don't seem to go towards higher demand; they went towards building up inventories, which have reached record high levels. So basically China uses the current soft copper market and low prices to stock up on this metal. If so, the recent recovery in the copper won't last long and once China stops buying copper for storage, which will eventually occur, prices will change direction and decline again. After all, China's economy isn't heating up: For one, manufacturing conditions aren't improving - the latest Caixin Manufacturing PMI slipped to 48, which means the manufacturing sectors are contracting. Second, the housing market - a major sector that uses copper -- is still a mess - home prices continue to rise while there is still oversupply mostly in smaller cities - and it could eventually lead to a total decline in number of houses constructed.

Therefore, it's too soon to consider the recent rise in China's copper imports as an indication for growing demand for copper let alone a sustainable growth that will keep driving up copper prices.

Another issue that helped pull up copper prices is the weaker dollar. The recent dovish statement issued by the FOMC provided another blow for the greenback to drag it down against other currencies. But this devaluation isn't likely to last long considering other central banks are moving forward in slashing rates and expanding their QE programs - most notably the ECB and BOJ.

But over the past few weeks, these global developments helped boost shares of FCX. And based on the above, these accommodating conditions may not last long, which will lead to a drop in copper prices.

This isn't to dismiss the efforts of Freeport to pull out of its dire situation: The company has made some changes including selling its 13% share in Morenci unincorporated joint venture to Sumitomo Metal Mining for $1 billion in cash. This event, as I have pointed out in the past, was a good move by Freeport as it brought in more than the NPV of these 13% at the prevailing copper prices. Even at $2.3 per pound, the NPV comes to only $900 million compared to $1 billion. The breakeven point is at $2.4. And while copper prices won't remain this low forever, the company's high debt burden requires it to sell assets. So selling assets at a profit in today's low copper prices is the best the company could expect at this stage. The company also reduced its capex and lowered its target operating costs. But even after considering these changes the company still faces high level of risk not only due to its high debt burden, but also because of the current state of copper.

Bottom line

The company is trying to improve its balance sheet and cash flow but the risk remains elevated. The stock's rally is mostly based on the latest market developments: China's high imports and the weaker dollar. And based on the projected market conditions, copper prices could resume their downward trend in the coming months as production remains well above consumption and demand isn't expected to improve much this year. This could all change once these conditions reveres course. For more please see: Freeport-McMoRan: It Will Get Worse before It Gets Any better

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.