Freeport-McMoRan Can't Overcome China Weakness

While signs existed last week that Freeport-McMoRan Copper & Gold (NYSE: FCX  ) was close to a resolution in Indonesia, the stock is going to have a much harder time overcoming the plunging copper prices due to China. As with most commodities, China is the engine that drives demand and ultimately pricing of copper. In the last few years, the Asian power has grown to account for roughly 40% of copper demand worldwide.

Freeport-McMoRan is a leading global mining company with interests in copper, gold, and oil. The miner has a mix of mines throughout North America, South America, the Democratic Republic of Congo, and Indonesia. The mix of commodities and geographic locations helps it overcome political issues in any particular country, but the one thing the company won't overcome is plunging copper prices due to weak demand in China.

Despite the rebounding demand in the U.S. and an improving Europe, any hard landing in China would have a devastating impact on copper prices, which spent the last few years holding strong above the key $3 per pound level. The recent plunge below $3/lb is very concerning and something that Freeport-McMoRan and other copper-related securities like Southern Copper (NYSE: SCCO  ) and the iPath Copper ETN  (NYSEMKT: JJC  ) can't overcome. The move to diversify into oil and natural gas will help Freeport-McMoRan outperform the others focused completely on copper, but the move might not be enough to keep up with the market.

China economic issues
In the last few years, China has grown to account for roughly 40% of copper demand worldwide. Lately though, the economic news out of the communist country has been concerning. First, the export data saw an unexpected plunge of 18% when the expectations were for a positive number. Next, the industrial output and retail sales numbers both disappointed slightly, though both numbers were still hugely positive. For example, retail sales were still up 11.8% over the prior year, yet expectations were for a larger 13.5% gain.

These fears, along with credit concerns, have the market concerned that copper used for collateral on loans in China will flood the market. In response, copper prices plunged below $3/lb for the first time since the summer of 2010. During the financial crisis, the price plunged below $2/lb.

At the same time, the London Metals Exchange, or LME, is showing inventories absolutely plunging. The 253,000 tones now in stock are nearing the lows for the last five years. Investors no longer pay the same level of attention to this exchange considering the importance of China, but the low inventory level could provide some support to the copper market.

Freeport-McMoRan copper impact  
In 2013, Freeport-McMoRan obtained roughly 64% of revenue from copper. The company obtained an average price of $3.36/lb for the copper sold during the year. A drop to the recent levels around $2.95/lb is already a 10% hit to revenues. More importantly, the company forecast 2014 operating cash flows of $9 billion based on a $3.25/lb price for copper, so having the price plunge below $3/lb within a month of that forecast clearly caught its management team off guard. The ultimate impact to Freeport-McMoRan is $370 million for each $0.10/lb movement in copper prices.

The iPath Copper ETN took larger hits since the investment vehicle is 100% focused on copper. The goal of the iPath Copper ETN is to directly mimic the price of copper. While Southern Copper is completely focused on copper production in Mexico and Peru, the company is very profitable, so it'll take more than a sudden 10% drop in copper prices to $2.95/lb to disrupt the strong cash flow. The bigger issue with Southern Copper has been the downshift in operations from extremely high margins to more normal levels.

Bottom line
Freeport-McMoRan remains a top notch miner with global diversification to overcome all types of political risks, including the recent flare up in Indonesia -- yet the company can't overcome economic weakness in China. If the recent slowdown in Chinese economic data continues to fuel lower copper prices, Freeport-McMoRan will see a big hit to operating cash flows. According to company-provided numbers, the recent $0.30/lb drop to copper prices will hit operating cash flows by over $1 billion this year alone.

Freeport-McMoRan might be the best investment in the copper neighborhood, which includes Southern Copper and the iPath Copper ETN, but it still isn't immune to lower copper prices. 

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