Freeport-McMoRan: Good Third Quarter Earnings With Indonesia Deal Almost Completed

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About: Freeport-McMoRan Inc. (FCX), Includes: AMT, BA, DLR, EOS, HD, JNJ, OHI, SLP, TXN, V
by: William Stamm

Summary

Freeport-McMoRan's third quarter earnings were $0.38 compared to last year at $0.34 and beat expectations by $0.04.

Cash flow is projected to be over $3.7 billion in 2018 at today's copper price and will be higher if the copper price increases as expected long term.

Freeport-McMoRan's three-year forward CAGR of 86% (S&P CFRA) is unbelievable and will give great growth with the expanding world economy, population, and demand for copper.

Freeport-McMoRan has a negative overhang since the deal with Indonesia has not been completed but is expected to be done before the end of the year.

Freeport-McMoRan (FCX), one of the largest mining companies in the world, is a buy for the growth value investor. Freeport-McMoRan has steady growing cash flow as the demand for copper increases, and future dividend increases should come as the cash flow increases each year. The stock comprises 1.2% of The Good Business Portfolio, my IRA portfolio of good business companies that are balanced among all styles of investing.

When I scanned the five-year chart, Freeport-McMoRan has a poor chart crashing in 2015 from the drop in oil prices. The end of 2016 and 2017 have shown a strong recovery as cash flow grows, with a downturn in 2018 to date because of the lower price of copper. Recent trade problems with China have caused a further downturn, but I feel this has been overdone

Chart FCX data by YCharts

Fundamentals of Freeport-McMoRan will be reviewed on the following topics below.

  • The Good Business Portfolio Guidelines
  • Total Return and Yearly Dividend
  • Last Quarter's Earnings
  • Company Business
  • Takeaways
  • Recent Portfolio Changes

I use a set of guidelines that I codified over the last few years to review the companies in The Good Business Portfolio (my portfolio) and other companies that I am reviewing. For a complete set of the guidelines, please see my article " The Good Business Portfolio: Update to Guidelines, August 2018". These guidelines provide me with a balanced portfolio of income, defensive, total return and growing companies that hopefully keeps me ahead of the Dow average.

Good Business Portfolio Guidelines

Freeport-McMoRan passes nine of 11 Good Business Portfolio Guidelines, a good score (a good score is 10 or 11). These guidelines are only used to filter companies to be considered in the portfolio. Some of the points brought out by the guidelines are shown below.

  1. Freeport-McMoRan does not meet my dividend guideline of having dividends increase for 8 of the last ten years and having a minimum of 1% yield, with four years of increasing dividends over the past ten years and a 1.0% yield. Freeport-McMoRan is, therefore, a poor choice for the dividend growth investor. The payout ratio of dividends is low at 12%. After paying the dividend, this leaves plenty of cash remaining for investment in expanding the business, reducing the debt and increasing the dividend as the cash flow grows.
  2. I have a capitalization guideline where the capitalization must be greater than $10 Billion. FCX passes this guideline. FCX is a large-cap company with a capitalization of $15.5 Billion. Freeport-McMoRan 2018 projected cash flow at $3.7 Billion is good allowing the company to have the means for company growth and debt reduction.
  3. I also require the CAGR going forward to be able to cover my yearly expenses and my RMD with a CAGR of 7%. My dividends provide 3.3% of the portfolio as income, and I need 1.9% more for a yearly distribution of 5.2%. The three-year forward S&P CFRA CAGR of 86% meets my guideline requirement. This good future growth for Freeport-McMoRan can continue its uptrend benefiting from the continued demand for copper in the United States and foreign countries. All we need is a trade deal with China.
  4. My total return guideline is that total return must be greater than the Dow's total return over my test period. FCX fails this guideline since the total return is -58.95%, less than the Dow's total return of 50.18%. Looking back five years, $10,000 invested five years ago would now be worth $3,800 today. This makes Freeport-McMoRan a poor investment for the total return investor looking back but has strong future growth as the economy continues to grow and the cash flow is increasing.
  5. One of my guidelines is that the S&P CFRA rating must be three stars or better. FCX's S&P CFRA rating is five stars or strong buy with a target price to $17, passing the guideline. FCX's price is presently 42% below the target. FCX is under the target price at present and has a low PE ratio of 7, making FCX an excellent buy at this entry point. For sure the price of copper will go up as demand becomes more than supply over the next two years.
  6. One of my guidelines is would I buy the whole company if I could. The answer is yes. The cash flow is great making FCX a good business to own for the growth and the value investor. The Good Business Portfolio likes to embrace all kinds of investment styles but concentrates on buying businesses that can be understood, makes a fair profit, invests profits back into the business and also generates a fair income stream. Most of all what makes FCX interesting is the potential long-term demand for copper which would produce strong positive cash flow. At the present entry point, FCX looks like great speculation for strong future earnings and cash flow gain when the trade dispute with China is settled. The President has had a good record so far, and most likely a compromise will be made between China and the United States.

Total Return and Yearly Dividend

The Good Business Portfolio Guidelines are just a screen to start with and not absolute rules. When I look at a company, the total return is a key parameter to see if it fits the objective of the Good Business Portfolio. Freeport-McMoRan loses against the Dow baseline in my 59.0-month test compared to the Dow average. I chose the 59.0 month test period (starting January 1, 2014, and ending to date) because it includes the great year of 2017, and other years that had fair and bad performance. The poor total return of -58.95% makes Freeport-McMoRan a very poor investment for the total return investor over my test period. FCX has a below average dividend yield of 1.1% and has had increases for four years of the last ten years, making FCX also a poor choice for the dividend growth investor. The dividend has been restarted at $0.05/Qtr. or 1.1% and the cash flow should allow increases easily on a yearly base as the debt is reduced. FCX is a speculation on the price of copper.

DOW's 59.0 Month total return baseline is 50.18%

Company name

59 Month total return

The difference from DOW baseline

Quarterly dividend percentage

Freeport-McMoRan

-58.95%

-109.13%

1.1%

Click to enlarge

Last Quarter's Earnings

For the last quarter on October 24, 2018, Freeport-McMoRan reported earnings of $0.38 that beat by $0.04 expected earnings of $0.34, compared to last year at $0.34. Total revenue was higher at $4.91 billion more than a year ago by 13.9% year over year and beat expected revenue by $410 million. This was a good report with bottom line beating expected and the top line increasing with a good increase compared to last year. The next earnings report will be out January 2019 and is expected to be $0.21 compared to last year at $0.51 a reduction as Grasberg transitions to under-ground development. The under-ground development will pay back this reduction in increased output when it is completed with the rights to manage the Grasberg mine until 2041.

The graphic below shows the cash flow and CAPX management of the company earnings.

Source: FCX Earnings call slides

Business Overview

Freeport-McMoRan is one of the largest mining companies in the United States and worldwide.

As per excepts from Reuters

Freeport-McMoRan is a mining company. The Company operates through geographical assets with proven and probable reserves of copper, gold, and molybdenum, and traded copper producer. The Company's segments include refined copper products, copper in concentrate, gold, molybdenum, oil and other. The Company's segments include the Morenci, Cerro Verde, Grasberg copper mines, the Rod & Refining operations and the United States (U.S.) Oil and Gas Operations. The Company has organized its operations into five divisions, which include North America copper mines, South America mining, Indonesia mining, and Molybdenum mines. The Company's portfolio of assets includes the Grasberg minerals district in Indonesia, copper and gold deposits, and mining operations in the Americas, including the large-scale Morenci minerals district in North America and the Cerro Verde operation in South America."

Overall Freeport-McMoRan is a great business with 86% CAGR (S&P CFRA) projected growth as the worldwide economy grows going forward with the increasing demand for copper. The good cash flow growth provides FCX the capability to continue its growth as the business increases by reducing debt and investing in the expansion of existing facilities.

The graphic below shows the decrease of inventories for Freeport-McMoRan versus the copper price. The present price for copper at $2.65. Even at this price, yearly cash will be over $3.7 billion in cash available in 2018 for increasing dividends and reducing debt.

Source: FCX Earnings call slides

The Fed has kept interest rates low for some years, and on September 26 they raised the base rate 0.25%, which was expected. I believe that they will not raise the rates anymore this year, but will go slow the rest of 2018, which should help keep the economy on a growth path. If infrastructure spending can be increased, this will even increase the United States growth going forward with better economics for the consumer. The recent downdraft in the market may slow down the FED as they see the reaction to what they have done.

From October 24, 2018, earnings call Richard Adkerson (Chief Executive Officer and President) said

It's been a very active quarter for us here at FCX. Results from our global mining operations have been solid; our teams continue to execute our plans in a very effective way. In Indonesia, we had an important milestone in progressing our efforts to reach stabilization of our business there in terms of our negotiations with the government with the signing of definitive divestment agreements on September 27.

Operations, current operations in Papua have been strong, and we've made important progress in transitioning the Grasberg ore body mining from open pit to underground, so we'll talk about that.

We are continuing our sharp focus on the important things about our business to build shareholder value. Our unit net costs are at $0.93 a pound, significantly below last year and in line with our plans, it does reflect for the nine months $0.02 as a result of the successful settlement of our labor situation in Cerro Verde and Peru, so that was very good.

Operating cash flows exceeded CapEx in the third quarter by $740 million [ph], $2.5 billion to-date. Net debt is down $2 billion from the start of the year. And this agreement with Inalum is really important. It establishes the path to reaching long-term stability and de-risk our operations over the long-term in Indonesia.

The copper market, it's a paradox. To be frank with you, it's a paradox right now. Physical markets are tight. Fundamental drivers remain very positive and yet sentiment about the commodity and about companies like ours in the investor marketplace is what it is and you know their concerns about global growth in China and so forth. But when you look at the fundamentals and look at this drop in global copper exchange stocks, and to see the copper price in that slide parallel to each other is very unusual in our industry typically when inventory stocks drop and they're also dropping at our customers, that indicates higher copper prices, but that's not what we experienced since June.

But when you look at the fundamentals, U.S. constructions and manufacturing remained positive, Europe is steady and positive, large Chinese fabricators are running at higher rates. Our customers have strong order books for us in the United States and business in China is good. Cathode availability is tight globally. There's issues with smelters disruptions in Chile and elsewhere in India. China is constraining scrap. Global stocks are down 40%, since the copper price was well over $3, almost $3.30 in early June, and this is a multi-year low stocks. But speculators are bearish on sentiment and macro drivers, and this is having a significant impact on price."

The graphic below shows the main points of the Grasberg FCX agreement that will be good for the company and Indonesia.

Source: FCX Earnings call slides

This shows the feelings of top management to the continued growth of the Freeport-McMoRan business with an increase in future growth. FCX has good constant cash flow and will continue to increase as the world economy grows.

The graphic below shows the 2018 goals that will continue to bring cash flow to the stockholders.

Source: FCX Earnings call slides

Takeaways

Freeport-McMoRan is a good investment choice for the growth value investor with it's above average cash flow and increasing future demand for copper. Freeport-McMoRan is 1.2% of The Good Business Portfolio and will be held as a speculation on the price of copper increasing from a trade deal with China and normal increases for the demand of the metal. If you want a growing value play on copper demand, FCX may be the right investment for you. Freeport-McMoRan has a negative overhang since the deal with Indonesia has not been completed yet but should be done by the end of 2018. It is in the interest of both FCX and Indonesia to make a deal, FCX wants to mine copper and Indonesia wants the tax income.

Recent Portfolio Changes

I intend to watch the earnings reports for the companies in the portfolio and may finally decide to trim my high flyers that are over 8% of the portfolio so I can invest in good companies on my buy list.

  • On October 10 trimmed Home Depot (HD) from 10.1% of the portfolio to 9.6%. I love HD but don’t want it to get above 10% of the portfolio.
  • On October 10 added starter position of VISA (V) at 0.4% of the portfolio.
  • On August 22 increased the percentage of DLR to 3.3% of the portfolio, I want to get this REIT to a full position of 4%.
  • On August 15 sold all remaining Amerisource Bergen(ABC) in the portfolio.
  • On August 9 reduced Amerisource Bergen(ABC) to 0.4% of the portfolio. I will most likely sell the remainder of ABC next week. The company margin is very thin, and I don't like the present pressure of the opioid crisis. The risk has gotten too high versus the reward.
  • On July 12th bought a small starter position (0.1% of the portfolio) in Simulation Plus (SLP) a small software company that helps test/simulate new drugs before they are released. SLP is a very speculative investment and should be watched carefully.
  • On June 20th closed out covered calls and sold KHC position, I needed some cash. I got a better price using the calls but missed some of the recent gains.
  • On June 8th sold KHC July 57.5 calls against the position and will make 4% if the KHC price remains the same. The calls are now in the money, and I may move them up and out when the time value is small.
  • On May 14th, I trimmed the position of Eaton Vance Enhanced Equity Income Fund II(EOS) from 9.2% of the portfolio to 8.9%. I still like EOS and don't want to overweight this fund which is high in technology companies.
  • On March 29 increased position of American Tower (AMT) to 0.8% of the portfolio, I will continue adding to this position as cash is available.

The Good Business Portfolio trims a position when it gets above 8% of the portfolio. The four top companies in the portfolio are, Johnson & Johnson (JNJ) is 8.5% of the portfolio, Eaton Vance Enhanced Equity Income Fund II (EOS) is 8.0% of the portfolio, Home Depot is 8.7% of the portfolio and Boeing (BA) is 13.9% of the portfolio. Therefore BA, EOS, JNJ, and Home Depot are now in trim position, but I am letting them run a bit since they are great companies.

Boeing is going to be pressed to 14% of the portfolio because of it being cash positive on 787 deferred plane costs at $316 Million in the first quarter of 2017, an increase from the fourth quarter. The second quarter saw deferred costs on the 787 go down $530 Million a big jump from the first quarter. The second quarter of 2017 earnings was fantastic with Boeing beating the estimate by $0.25 at $2.55. The third quarter of 2017 earnings were $2.72 beating the expected by$0.06 with revenue increasing 1.7% over last year, another good report. The first quarter earnings for 2018 were unbelievable at $3.64 compared too expected at $2.64. Farnborough Air Show sales in dollar value just beat out Air Bus by about $6 Billion, and both companies had a great number of orders. The second quarter earnings beat expectations by $0.06 at $3.33, but a good report was hurt by a write off expense on the KC-46 which should start delivery in October of 2018. Boeing recently got an order for 18 more KC-46A planes. As a result of the good third-quarter earnings, S&P CFRA raised the one-year price target to $ 450 for a possible 20% upside potential.

JNJ will be pressed to 9% of the portfolio because it's so defensive in this post-BREXIT world. Earnings in the last quarter beat on the top and bottom line and Mr. Market did like it. JNJ has announced a dividend increase to $0.90/Qtr. which is 56 years in a row of increases. JNJ is not a trading stock but a hold forever; it is now a strong buy as the healthcare sector remains under pressure.

For the total Good Business Portfolio, please see my article on The Good Business Portfolio: 2018 2nd Quarter Earnings and Performance Review for the complete portfolio list and performance. Become a real-time follower, and you will get each quarter's performance after this earnings season is over.

I have written individual articles on JNJ, EOS, GE, IR, MO, BA, PEP, ADI, Omega Health Investors (OHI), Texas Instrument (TXN), Digital Investors Trust (DLR) and Home Depot that are in The Good Business Portfolio and other companies being evaluated by the portfolio. If you have an interest, please look for them in my list of previous articles.

Of course, this is not a recommendation to buy or sell, and you should always do your own research and talk to your financial advisor before any purchase or sale. This is how I manage my IRA retirement account, and the opinions of the companies are my own.

Disclosure: I am/we are long BA, JNJ, HD, OHI, MO, IR, DLR, GE, PM, LB, PEP, ADP, FCX, V.

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.