Freeport-McMoRan: Not The Time To Sell

| About: Freeport-McMoRan Inc. (FCX)

Summary

Copper prices should continue the rise over the next two years as the demand rises.

Gold prices have gone up considerably, and the average realized price for 2016 will be higher.

Rising prices plus growing production means wider profit margins.

Losses are mainly coming from the oil and gas assets in the shape of impairments, which is a non-cash expense.

Fundamentals of the industry as well as the company are strong.

Freeport-McMoRan (NYSE:FCX) has had an amazing six months, as the stock has more than quadrupled. There are now doubts among shareholders or new investors about the further rally. However, I believe the stock price has a lot of room to rise over the next few months, based on a number of reasons. Current shareholders should hold on to the stock, and investors looking for long-term investments should certainly consider FCX.

The first reason to be optimistic is that the market for copper has shown an immense recovery, and the future outlook is looking even more promising. As copper has a number of applications, it is one of the key commodities that has to play its role in the upcoming recovery of the global economy. One of the biggest uses of this commodity is in the energy sector - wherever energy transmission is needed, copper will benefit. Global energy production is rising due to the growing demand as well as a focus on the environment. In the developed world, concerns about the environment have led to the rise of renewable energy - new projects mean more copper being used. On the other hand, development work in the less fortunate areas of the world cannot be completed without electricity. So, the development projects in these areas (parts of Asia, Africa and South America) is also creating a lot of demand for copper. On the back of this strong demand and the hopes of recovery in the global economy, copper price has been rising, and it is expected to rise further over the next few months.

Copper prices per pound are at around $2.27, lower than the realized price of $2.42 per pound last year for Freeport-McMoRan. However, the overall production for 2016 will be considerably higher. At the end of the last year, the production target for 2016 was 5.1 billion pounds, which has now come down to 5.015 billion by the end of the first quarter. This shows the company is not getting the desired results in its production efforts; however, the overall production target still remains substantially higher than the last year's, when total copper production was 4.1 billion pounds.

Increased production will certainly result in higher overall profit, as the gross margin of the company is extremely strong. Unit net cash costs at all of its four copper mines ranged from $1.09 to $1.74 - for the current year, these costs are further coming down due to the cost-cutting efforts and new investments. So, the gross profit margin will largely remain unaffected even if the company gets an average selling price 10-15 cents lower than that in the last year. However, the overall rise in production will result in higher gross profit numbers. When we look at the overall loss numbers for Freeport-McMoRan, we should keep it in mind that the losses are mainly coming from its oil and gas assets, and these losses are, in fact, non-cash charges/writedowns or impairments. In terms of cash, the company is not losing too much. These impairments or writedowns happen when the recoverable value of an asset is lower than the recorded value. It should also be kept in mind that marking to market means as the oil prices recover, the value of these assets will rise again and we might see non-cash gains in the future.

The second quarter should have lower impairment charges, as oil has had a strong rally and it has stabilized near $50 per barrel. However, at these prices, one should not expect an upward revision of previously written down or impaired assets. It was a wise move to delay the IPO of its oil and gas assets, because the price would have been underwhelming, especially as the market was near the bottom. The next 12 months will be key for oil, as the supply-demand balance is looking more likely to be achieved by the end of 2017, and this might provide a good opportunity for Freeport-McMoRan to either sell its oil and gas assets or convert them into a separate business. Offshore assets will likely take longer to sell, as the major oil & gas companies will stay away from offshore investments until oil prices reach near their previous highs. The cost of production at offshore assets is much higher than at onshore assets, which might deter buyers.

Gold is also experiencing a good rally, and production for 2016 is expected to be over 1,800 thousand ounces. Realized price per ounce for gold was just $1,129 in 2015. It is now trading over $1,300. This means it is highly likely that the average price per ounce for gold will be higher with the rising production numbers. The gold segment will get a double boost, and gross margin will rise further.

These developments should allow the company to report a healthy profit over the next few quarters and also increase its cash position. Despite reporting losses, the cash flows remain strong - first-quarter operating cash flows were $740 million, and cash balance of over $331 million. FCX management made a wise decision to sell some of its mining assets instead of dumping oil and gas assets when there wasn't a bright chance to get a good price. The company has enough mining assets to fuel its future growth.

I believe FCX is still a good buy at current price, because the company will grow substantially in the next 2-3 years. Investors with a long-term view should not be worried about these small price fluctuations. The fundamentals are strong, cash flows are solid and production is growing - the realized prices for key segments are also rising, which means profits and cash flows will go up further.

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.