Why Freeport-McMoRan Has Strong Upside Potential

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About: Freeport-McMoRan Inc. (FCX)
by: Alpha Investor
Summary

FCX is set to benefit from an improvement in copper pricing, which will be driven by an increase in copper consumption in both China and the U.S.

China’s copper demand will increase 15% in the next five years, while infrastructure developments in the U.S. will also drive copper demand, thereby enhancing FCX’s addressable market.

Due to the increase in demand copper prices are expected to increase to $2.73/pound next year as compared to an average of $2.23/pound this year.

Due to this $0.50/pound rise in copper pricing, FCX’s operating cash flow for 2017 should increase by more than $1.6 billion.

China's robust copper imports this year have pushed the price of the metal to 18-month highs. Looking ahead, it is quite likely that copper prices will continue to move higher as infrastructure investment in both China and the U.S. gains momentum. This will prove to be a tailwind for copper miner Freeport-McMoRan (NYSE:FCX), which will witness strong growth in its EBITDA and cash flow in a stronger copper pricing scenario.

So, in this article, we will take a look at the factors that will continue to push copper higher and why Freeport is well-placed to benefit from an improvement in pricing.

Infrastructure investments will drive copper consumption

As mentioned earlier in the article, copper prices hit an 18-month high earlier this month after it emerged that China's copper imports for November shot up 31% month over month to 380,000 tons. At the same time, China's imports of copper concentrate have increased 31% so far in 2016 to 15.4 million tons as compared to last year.

Since China is the largest importer of copper in the world as it accounts for 45% of global consumption, it is not surprising to see why copper prices have shot up due to higher imports by the country. More importantly, it is likely that the price of copper will continue to soar higher in the long run as China's copper demand will continue to increase on account of infrastructure investments.

For instance, under the 13th five-year plan of the Chinese government from 2016-2020, it is expected that the country's demand for copper will go up in excess of 15% as investments are made in sectors such as renewable energy, power, construction, and electric cars. This year itself, China's copper demand has increased 3.5% on the back of higher infrastructure investments, which bodes well for the country's copper imports in the long run.

On the other hand, an expected surge in infrastructure investments in the U.S. will prove to be another growth driver for copper pricing. This is because under the incoming government, investments of $1 trillion are expected in the renovation of public infrastructure in the U.S. Construction accounts for a fourth of the copper consumption across the globe, so an increment in infrastructure development in the country will prove to be a tailwind for the commodity.

Higher copper pricing will be a tailwind for Freeport

As a result of the improving demand prospects in two key markets such as the U.S. and China, copper pricing is expected to rise further in the long run. For instance, according to the Economist Intelligence Unit, copper prices will go up to $2.73 per pound next year. In comparison, so far this year, copper prices have averaged $2.23 per pound.

At this level of copper pricing in 2016, Freeport-McMoRan has generated operating cash flow of $2.6 billion for this year. Now, as the price of copper increases next year, Freeport's operating cash flow over the same time frame will be higher than this year. This is because Freeport's operating cash flow increases by $325 million for a change of $0.10/pound in the price of copper.

Therefore, as copper prices are expected to be higher by $0.50 per pound in 2017 as compared to 2016's average levels, Freeport's operating cash flow for the entire year should increase by more than $1.6 billion. More specifically, for the first three quarters of the year, Freeport's operating cash flow should go up by $1.2 billion if we spread the expected increase in cash flow evenly across the year.

This means that in the first three quarters of 2017, Freeport-McMoRan's operating cash flow will increase by more than 46% as compared to current year's levels. Hence, an increase in copper prices will prove to be a tailwind for the financial performance of Freeport-McMoRan going forward.

Conclusion

As the discussion above indicates, Freeport-McMoRan is set to benefit from further growth in copper pricing next year. As the company's financials improve, it should be able to deliver more upside due to an improved earnings performance. So, Freeport looks like a good investment going into 2017 on the back of the positive copper market fundamentals.

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.