Freeport-McMoRan: Big Capital Returns Aren't The Answer

Summary

• Freeport-McMoRan has a bad history of hiking dividends in the good times that are cut in the lean years.
• With copper over $4/lb, the copper miner is still poised to produce close to $7 billion in FCF next year.
• The company plans to return up to 50% of FCF to shareholders, but the company has a bad history of returning cash right before copper collapses.
• The stock is extremely cheap trading at only 4x EV/EBITDA targets.
• This idea was discussed in more depth with members of my private investing community, Out Fox The Street. Learn More »

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The biggest question with Freeport-McMoRan (NYSE:FCX) is whether strong cash flows now can lead to a rewarding future for shareholders. A lot of times high commodity prices lead to lower demand and an eventual collapse in prices. My investment thesis is Bullish on the stock, especially if the company builds up a strong balance sheet in the current good times.

Big Dividends Aren't The Solution

Anyone just needs to look at a historical chart to see how Freeport-McMoRan has been a very volatile stock due to the price of copper. The stock has rallied and collapsed multiple times with long-term shareholders no better off with the Freeport-McMoRan peaking around in both 2008 and 2011.

One of the main issues is how the copper miner has weakened the balance sheet in the past. Freeport-McMoRan has a history of paying large capital returns in the good times and eliminating those returns in the bad times. The big question now is whether the company is willing to build up a balance sheet with a strong cash position to cushion the weak times with reinforced capital returns.

Back in 2012 when copper prices last soared above $4/lb, Freeport-McMoRan hiked the quarterly dividend to $0.3125 plus paid several special dividends. Ultimately, the company cut the dividend in 2015 as copper prices collapsed. And again, the copper miner cut the minimal $0.05 quarterly dividend to $0.00 in 2020 due to covid.

Data by YCharts

Looking at the stock, Freeport-McMoRan didn't actually rally on the dividend hike back in 2012 because the key to the investment story is consistent cash flows, not big capital returns. The company had already gone through a period during the financial crisis where the dividend fluctuated with copper prices. Also, the stock rallied substantially off the 2020 lows when the dividend was cut and prior to any meaningful increase in capital returns.

The best option for the copper miner is to build up a positive cash position and use any future weakness to repurchase shares and at the least maintain minimal dividend levels. The company ended Q2'21 with net debt of only $3.4 billion.

Source: Freeport-McMoRan Q2'21 presentation

Back on February 2, Freeport-McMoRan announced a plan to return up to 50% of free cash flows to shareholders going forward starting in 2022. In addition, the company implemented a $0.075 quarterly dividend first payable on May 1. CEO Richard C. Adkerson seemed to indicate the company would implement a far more balanced approach to capital returns:

Our Board's action reflects strong performance of our business and execution by our team in 2020, which established a solid foundation for future cash flow generation. The policy of combining a base dividend, which can be sustained in a range of market conditions, with a performance based payout framework, allows us to enhance long-term value for shareholders with a strong balance sheet, providing cash returns to shareholders reflective of market conditions and building long-term values in our undeveloped resources.

The current quarterly dividend of $0.075 only amounts to $111 million quarterly payout and $444 million in annual dividend payments.

Still Minting Cash

These payouts are minimal compared to the current cash flows with copper at $4.15/lb. Freeport-McMoRan has guided to 2022 operating cash flows of at least $9.0 billion with capex of ~$2.2 billion. The company will have FCF in the range of $6.8 billion while only spending $0.4 billion on dividends.

Source: Freeport-McMoRan Q2'21 presentation

The company proposes spending up to another $3.0 billion next year on capital returns. With the market cap around $50 billion, Freeport-McMoRan could acquire ~6% of the outstanding shares.

While this would provide a huge boost to the stock in the short term, the company is far better over the long term using the other 50% of FCFs on turning the balance sheet into a net cash position. On the next downturn in copper, Freeport-McMoRan can utilize a strong balance sheet to invest in the company via repurchasing stock on the cheap or by acquiring other copper assets.

The long-term demand equation for copper is undeniable due to surging EV and renewables demand. Copper prices have the potential to soar in the next couple of years due to low supply and limited production increases. In the near term, the potential exists for prices to reach lofty levels including an incredible $9/lb forecast by BoA commodity strategist Michael Widmer. Regardless, investors and management always need to remember this volatile chart on copper over the long term.

Copper Prices - 20 Years

MacroTrends

Copper prices now trade at a much higher level than pre-2005 levels, but the prior runs to $4/lb all ended with at least 50% dips in the price of copper. The company would be wise to continue paying off debt while slowly increasing capital returns.

Takeaway

The key investor takeaway is that Freeport-McMoRan is now poised to profit from the smart repaying of debt over the last few years. The best way to reward shareholders is to build up the business on the next downturn considering the long-term future of copper is extremely bright. The worse plan is to boost the dividend to unsustainable levels during the next downturn.

The stock is extremely cheap trading at only 4x EV/EBITDA targets. As long as the company doesn't make any aggressive moves up here, Freeport-McMoRan could finally become investable for the long term.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.

The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock, you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.