Buyer Beware: Freeport-McMoRan Optimism May Not Be Warranted

| About: Freeport-McMoRan Inc. (FCX)
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Freeport-McMoRan Copper & Gold (NYSE:FCX), a major producer of copper and gold, has recently reported third-quarter earnings and while there were no major surprises for investors, it was clear that the company is grappling with higher production costs and concerns about demand in China - just like other major mining stocks including Alcoa (NYSE:AA), BHP Billiton (NYSE:BHP), Southern Copper Corp (NYSE:SCCO), Rio Tinto (NYSE:RIO) and Vale SA (NYSE:VALE) are dealing with. However, Freeport-McMoRan Copper & Gold has its own set of unique problems in Indonesia that threaten to impact it at the production level while during the earnings call, executives struck an optimistic tone about China. Nevertheless, Freeport-McMoRan Copper & Gold is still planning to increase copper production by 25% over the next three years. Hence and with all of the above in mind, is Freeport-McMoRan Copper & Gold a buy right now or should investors just take a wait and see approach?

The Freeport-McMoRan Copper & Gold Earnings Report

To begin, with the third quarter, Freeport-McMoRan Copper & Gold reported that revenue declined 15% to $4.42 billion while net income sank 22% from $1.05 billion (or $1.10) a year ago to $824 million ($0.86). According to the summary of analyst estimates from Yahoo! Finance, Wall Street had expected Freeport McMoRan Copper & Gold to report a 16.6% fall in revenue to $4.33 billion along with EPS of $0.71. Hence, third-quarter results were not that far from Wall Street's expectations.

It should be noted though that Freeport-McMoRan Copper & Gold was hit by higher-than-expected production costs across all divisions - a trend across the sector that's bound to continue. Specifically, net cash costs for copper rose from $0.80 to $1.62 a pound while copper for delivery in three months was down 14% year-over-year on the London Metal Exchange (it averaged $7,720.85 a metric ton during the quarter) over concerns about the Chinese economy. However, costs were also higher due to lower volumes and troubles in Indonesia.

Freeport-McMoRan Copper & Gold's Indonesia Problem

So just what are Freeport-McMoRan Copper & Gold's problems in Indonesia? To begin with, Freeport-McMoRan Copper & Gold owns the Grasberg mine, which the company says has the world's largest recoverable copper and gold reserves, in the Indonesian province of Papua on the island of New Guinea. That province has a problem with separatists who have been blamed for attacks in the area around the mine but the biggest headache for the company came in the form of a miners strike in July of last year that lasted for three months as workers demanded an increase in pay. Production was again halted in the first quarter for two weeks after more violence and there was another one-day strike at the beginning of October.

Moreover, Freeport-McMoRan Copper & Gold's third-quarter results were also impacted by lower ore grades at Grasberg due to changes in mining plans that delayed access to higher grades and higher costs. In fact, Indonesia unit net cash costs were $1.65 per pound in the third quarter verses a net credit of $0.48 per pound for the same period last year. Any interruption, changes in ore quality or rise in costs at the Grasberg mine will need to be closely watched because it accounts for 19% of the company's revenue.

Likewise, the mine is important for the government of Indonesia as it's a major contributor of taxes and royalties. Hence, the government also wants Freeport-McMoRan Copper & Gold and other foreign companies mining gold and copper to pay higher royalties to the government (a 10% royalty verses a 1% royalty for gold and a 3.5% royalty for copper) but it will be some time before a final decision is made and what impact it will have on the company's top and bottom line. It should also be mentioned that company executives sounded an optimistic tone about their negotiations with the government in the company's third quarter investor conference call but again, it will be some time before the final decision is made by the government.

Otherwise, it's worth noting that the local Indonesia headquarters of Freeport-McMoRan Copper & Gold was apparently on a list of targets compiled by local Islamic terrorists arrested in police raids during the last weekend in October. And while any concerns about terrorists targeting the company are probably overblown, any further reports about plots targeting the company and other western interests in the country could impact the company's stock price in trading immediately afterwards.

Freeport-McMoRan Copper & Gold's CEO is Optimistic About China

Meanwhile and in contrast to the growing skepticism surrounding China's growth rates, Richard C. Adkerson, the President and Chief Executive Officer of Freeport-McMoRan Copper & Gold, had struck a bullish note over China before earnings in a Bloomberg interview and seemed to remain upbeat during the earnings conference call. Specifically, he noted that the Chinese government is taking steps to stabilize the economy by providing incentives to consumers and by investing in the country's infrastructure. He also commented that Chinese inflation rates have been brought down and that the government has both the financial resources and the commitment to dealing with these issues. Hence, he said that Freeport-McMoRan Copper & Gold has seen strong demand for copper concentrates and copper cathodes with the company continuing to see a positive situation in China.

A Final Word About Freeport-McMoRan Copper & Gold

At the end of the day, investing in Freeport-McMoRan Copper & Gold right now would be a bet that things work out for the better in Indonesia (which is a good possibility but not certain) and that all of the China skeptics are wrong - a more uncertain prospect. Hence, if you are bearish on China, you probably don't want to invest in a mining stock like Freeport-McMoRan Copper & Gold right now.

Disclosure: I 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.