Freeport-McMoRan: Rally Fading, But Downside Risk Minimum

| About: Freeport-McMoRan Inc. (FCX)
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Summary

Freeport-McMoRan has bounced back sharply after a disastrous start to 2016.

Year to date, the stock is up almost 40%.

In recent weeks, Freeport-McMoRan has seen a pullback, but I don't see significant downside from current levels due to a range of factors.

Freeport-McMoRan (NYSE:FCX) is up almost 40% for this year. After bottoming out in late January, the shares have staged a remarkable comeback, driven mainly by a rebound in commodities. With the stock seeing a bit of a pullback in recent weeks, the question is whether FCX's rally is fading, and whether we will see the stock drop to levels seen in January.

The answer to the first question is "Yes." The rally is certainly fading, and given the company's near-term outlook, this is justified. FCX had dropped to multi-year low levels mainly due to fears over the company filing for bankruptcy. While FCX's high debt levels, mainly due to ill-timed acquisition of oil & gas assets, are a concern, its bankruptcy fears are certainly overblown. Remember that the company is sitting on some of the best copper assets out there. A recovery from the multi-year low levels was certainly warranted, and as commodities rebounded, FCX staged a remarkable recovery. It is not surprising to see a pullback now, as investors that entered at those multi-year low levels are taking profits, and rightly so.

As for the second question of whether FCX could potentially drop to the January levels, the answer is "No." And here is why. Freeport-McMoRan, because of the steps it has taken in the last six to eight months, expects its mining business to be free cash flow-positive, even if prices remain low. In a presentation in February, the company noted that it has stress-tested current operating plans at lower prices to ensure its adjusted mine plans are appropriate.

The second reason why I don't expect FCX to drop to January levels is the outlook for the copper market. While copper prices could remain under pressure in the near term, the mid- to long-term outlook for the red metal is one of the best in the commodities space. According to a recent report in the Financial Times, copper stocks on the London Stock Exchange have dropped 38% in 2016. Speculators anticipate prices to move higher. The Financial Times, citing data from Marex Spectron, notes that total long positions in copper are currently at levels not seen since July 2014.

Another reason why I don't expect FCX to drop substantially from current levels is because of the quality of its copper assets. The company has seen significant mining unit cost reductions in the past year. Unit net cash costs were at $1.53 per pound ($1.78 consolidated site production & delivery) in 2015, and these are expected to drop to $1.10 per pound ($1.34 per pound consolidated site production & delivery) in 2016. This makes FCX's copper assets extremely attractive. Indeed, the company sold a 13% interest in its Morenci mine earlier this year. Given the low unit net cash costs and the mid-term outlook for copper, FCX could get an excellent deal if it decides to offload some of its copper assets to reduce its debt. Reducing debt levels further (the proceeds from the Morenci deal will be used to repay debt) will significantly improve the company's risk/reward profile. More importantly, there might be interest in FCX's copper assets.

Remember that recently, Rio Tinto (NYSE:RIO) appointed Jean-Sebastian Jacques, who led the company's copper business, as CEO. Jacques will replace Sam Walsh in July this year. His appointment suggests that Rio might look to increase its focus on copper. Jacques, in fact, has been bullish on copper since last year, and has said that the market could turn to a deficit sooner than expected. Rio Tinto already has an interest in FCX's Grasberg mine in Indonesia, although it will get only a small share of the production until 2021 due to the terms of the contract. The Financial Times recently said in a report that Barclays analysts prepared a ranking of copper mines with high margins that Rio Tinto could acquire. The list excluded those mines that the Anglo-Australian would be unable to acquire. At the top of the list of mines Rio Tinto could acquire was FCX's Cerro Verde. According to the Financial Times, given Rio's limited options when it comes to high-margin copper mines, FCX is in a position to command significant premium for its Cerro Verde mine if it chooses to sell a stake.

The final reason why FCX does not have significant downside is oil. As I have noted before, it is the oil assets that have dragged down FCX and created fears of bankruptcy. But prices are showing signs of stabilizing, although they remain at multi-year low levels. If Saudi Arabia agrees to a production freeze later this month, the prices will find support. This will be a positive for FCX as the company looks to offload its oil & gas assets.

Disclosure: I am/we are long FCX.

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.