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Freeport McMoRan (FCX) research
Freeport McMoRan (FCX) is a company engaged in mining operations around the world. Subsequent to their recent merger with Phelps Dodge, they are neck-and-neck with Chile's state owned Codelco for the title of the world's largest copper producer at almost 4 billion pounds of copper production per year, and may well have taken the top spot by now, given the aging status of Codelco's mines. They are the undisputed leader in molybdenum production, with nearly 70 million pounds per annum. That figure will in all likelihood rise by approximately 30 million pounds annually with the anticipated re-opening of the company's Climax molybdenum mine in Colorado in 2010. The company also produces about 2.3 million ounces of gold annually. At current prices as of 24OCT07, the above production is valued at:
4 billion pounds of copper x $3.5344/pound = about $14.140 billion
70 million pound molybdenum x $34/pound = about $2.380 billion
2.3million ounces of gold x $763.30/ounce = about $1.756 billion
So while Freeport is capable of well over $4 billion in annual revenues from other metals, copper is by far their primary product. FCX has very low unit costs on its copper production, which would enable the company to weather any downturn in copper prices while still generating substantial cash flows. Their net unit cash costs per pound of copper produced thus far in 2007 is $0.65, though that figure rose substantially in the third quarter to $1.05 due to several factors. The major reason was the fact that production fell dramatically at the company's Grasberg mine in Indonesia while the company works through an area of lower grade ore. Second quarter production at the mine was 298 million pounds, which fell to 177 million in Q3. The company expects to be working this area of low grade ore at this mine until Q4 of 2008 as part of their planned mining sequence, and will therefore continue to experience lower production for the next 12 months at Grasberg. Working this portion of the pit is necessary in order to safely access the higher grade ore below, which is scheduled for mining during 2009-2011. Production in their North American mines rose from 335 million pounds in Q2 to 357 million pounds in Q3, while South American production rose from 338 to 377 million pounds over the same timeframe. Also affecting unit costs were lower gold, silver, and molybdenum production as an inherent by-product of the copper. Sales of those by-products, especially gold, are weighted towards the fiscal first half. Other factors include higher energy and labor costs. Even with the higher unit costs, though, gross margins are very high considering an average realized price per pound of $3.53.
There are many factors that affect global copper demand. The lowered demand associated with the weakness in the US housing market has been brought up as a possible drag on copper demand. While it's true that the average new-build home in the US contains approximately 400 pounds of copper, I see these concerns as being far overblown by the stock market since the entirety of US consumption only represents about 12% of global consumption, according to FCX' CEO Richard Adkerson during a 17OCT07 CNBC interview. The main factor in copper demand growth remains China's continuing economic boom. China has scant resources of copper ore, and must import the vast majority of its copper. According to a 19OCT07 article on xinhuanet.com, China's imports of copper ore fines, or concentrates, in the first eight months of 2007 rose 35.9% year-over-year to 3.192 million tons, which were valued at over $6 billion, a rise of 63.2%. That same article reported that global supply fell short of global demand by 260 million pounds in the first half of 2007, according to iscg.org. Global supply is projected to slightly outpace demand in 2008, but only by slightly over 1%. Therefore any supply constraints, or demand increases, will result in unmet demand.
In March of 2007, Freeport McMoRan completed their acquisition of Phelps Dodge. The $26 billion transaction was financed by a combination of debt, issuance of notes, and issuance of a very significant amount of FCX stock. Despite the highly dilutive nature of the transaction, the deal was very successful for FCX. As a former shareholder of PD, I recall the announcement vividly, and I also recall my ire at what I felt were meager terms for PD shareholders. I thought the company was worth quite a bit more. The merger took FCX from a one-pit miner to a global copper-production power, with major operations on four continents.
Analyst consensus is for FCX to earn $10.90 in FY2008. Their consensus is for earnings to grow at a rate of 37.5% over the next five years. I disagree with both of these numbers. I think the former is too light by half, and I think the latter is too heavy by half. My own guesstimates are for earnings of $15/share, and a medium-term earnings growth rate of 25% per year. That would yield a forward PEG of just under 0.3. During the Q3 conference call, the CEO disclosed that FCX would generate approximately $18 of excess cash over the next two years net of current dividend commitments, capex and debt-reduction payments. The CEO and the board are always looking for capex opportunities, but are focusing on finding highly accretive potential projects that will integrate into their existing infrastructure without requiring construction of all new processing facilities. The remainder of that $18/share is available for either a special dividend or a share repurchase, according to the CEO.
The company has some new production start-ups on the horizon to ensure earnings growth. The Climax mine near Leadville, CO is a virtual lock for a 2010 re-start, adding 30 million pounds of molybdenum production per year. Current spot price values that production at just over $1 billion per year in revenues. The mine is designed to facilitate rapid doubling of that production to should molybdenum prices warrant. Year-end 2010 production at Big Gossan near the Grasberg mine in Indonesia is expected to reach 135 million pounds of copper and 65 thousand ounces of gold per year at a current price revenue addition of $530 million per year. 2009 should see initial production at the Tenke Fungurume mine in the Democratic Republic of Congo. Expectations there call for 250 million pounds of copper and 10 million pounds of cobalt, of which 57.75% is Freeport's, for annual revenues of $824 million at current prices. So that's an estimated total of roughly $2.35 billion in annual revenues flowing in from new sources expected in the next two to three years even if metals prices remain where they are. That is 15% of current annual revenues.
One of the tenets of successful investing is an ability to find the drivers of future stock price appreciation before those drivers become recognized by the rest of the investing community. Some people call these drivers 'nuggets'. While I can't point to a single 'nugget' that makes FCX such a compelling investment in my mind, I can point to a lot of 'flecks' that more than add up to a nugget.
● The US only represents 12% of global copper consumption. I found this piece of data to be very surprising, and would have expected this figure to be much higher. Total building construction makes up roughly half of annual US copper usage, and residential construction is only a portion of that figure, so a homebuilding slowdown isn't a death knell to copper producers. The rapidly expanding economies of China and India represent a far larger portion of the global demand. China has meager copper ore reserves and must purchase copper on the open market. This set of facts is the closest thing I have to a full-fledged nugget.
● FCX does the bulk of its business overseas, thereby benefiting from continuing weakness in the dollar.
● FCX has a high likelihood of announcing either a special dividend or a substantial share repurchase plan in the near future.
● FCX operates in a high free cash flow business with substantial barriers to entry.
● With unit production costs so low, FCX would be profitable even with metals prices at much lower levels than they currently enjoy.
● FCX has great potential for organic growth from existing assets and concessions without the need to expend huge sums on exploratory and developmental operations.
There are a few other factors that are not 100% reliable, and therefore should not be considered in a straightforward analysis. However, they are compelling enough that I feel they warrant a mention.
● Since China must import the vast majority of its copper reserves, the Aluminum of China Company has announced publicly that it is on the prowl for overseas copper miners. As we learned with CNOOC's unsuccessful attempt to purchase Unocal in 2005, US regulators can and will block sales of US companies that they deem strategically important. Freeport would almost certainly be such a company. However, as with Unocal, there exists a possibility that another global player might step into the mix and make an offer if Chinalco expresses/announces specific interest in FCX.
● I'm almost embarrassed to even put this one in here, but since Jim Cramer mentioned it on his TV show, I suppose that I have to. In 1960, Fidel Castro's government nationalized Freeport's Moa Bay nickel mine. Cramer's argument is that when Castro passes away and US-Cuban relations normalize, that the mine will be returned to FCX' control. I highly doubt it, but that's what the wildman said.
I would highly for reccommend anyone interested in the stock to logon to the company's website and give their latest earning conference call a listen. You needn't listen to the Q&A so much as the presentation. Be sure to download the supplementary pdf at http://www.fcx.com/ir/2007present/3Q07CC-OCT07.pdf Slides 31-38 do a great job of showing why the recent production drop-off at Grasberg is just a planned, temporary dip.
FD: Yes I own this stock in RL. Alot of it. On margin, even.