Freeport-McMoRan Is Resilient Despite Indonesian Challenges

Despite the unresolved Indonesian issue, Freeport-McMoRan Copper & Gold (NYSE: FCX  ) posted strong quarterly results, driven by solid energy results and lower copper costs.

The largest publicly traded copper miner reported first-quarter 2014 operating earnings per share of $0.48, topping Wall Street estimates of $0.43 by 12%. The headline EPS of $0.49 was adjusted for a $0.01 gain from oil and gas derivatives. The beat was largely driven by the energy segment, where volume, revenue, and costs all came in better than market expectations.

Freeport-McMoRan also raised its 2014 oil and gas production guidance and maintained its debt reduction target; this, along with recent improvements in copper data points, should provide support to Freeport-McMoRan shares going forward. Year to date the stock has lagged behind its peers by 10%-15% and presents an attractive investment opportunity for investors who can look beyond the near-term Indonesian uncertainty.

Year to date, Freeport-McMoRan is down 10%; in comparison Southern Copper (NYSE: SCCO  ) is up 5%, BHP Billiton (NYSE: BHP  ) is up 4.5%, and Rio Tinto (NYSE: RIO  ) is down 2%.

Source: Google Finance

Upside potential
Freeport-McMoRan is continuing its path of strong execution. Despite near-term challenges, Freeport-McMoRan shares have upside potential as the company executes on its production growth plans and deleveraging targets. Moreover, shares should also appreciate as the company continues to unlock the value of its oil and gas business and possible value-accretive opportunities in the segment are monetized. 

Freeport-McMoRan shares are trading at a discount compared to its peers. It has a price/earnings ratio of 12.9 compared to Southern Copper's 15.5 and an industry average of 14.2. Similarly, Freeport-McMoRan is trading at a forward price/earnings of 11.4 compared to Southern Copper's 24.8. It has a price/book ratio of 1.7 compared to Southern Copper's 4.5 and an industry average of 2.2. Finally, Freeport-McMoRan has a price/sales ratio of only 1.6 compared to an industry average of 2.2 and Southern Copper's price/sales of 4.6. Freeport-McMoRan also has a very healthy dividend yield of 3.7%.

Deleveraging and asset monetization
Freeport-McMoRan continues to execute on its deleveraging plans. To achieve its target net debt level of $12 billion by 2016, the company is aiming for $2 billion in asset monetization. Both mining and oil and gas assets are on the table, and management has had discussions on both with third parties. In addition to divestitures, Freeport-McMoRan continues to consider joint venture or MLP options for its onshore oil assets.

Negotiations continue with the government of Indonesia
Freeport-McMoRan continues to work the Indonesian government to resolve the ongoing restrictions on the export of its concentrate. As a reminder, at the start of 2014, the Indonesian government banned exports of all unprocessed mineral ores including nickel and bauxite as part of a drive to promote the development of a refining industry. Freeport-McMoRan and Newmont Mining (NYSE: NEM  ) are two of the largest foreign miners in Indonesia, and both are affected by the government's decision.

Freeport-McMoRan operates under a Contract of Work (COW) with the Indonesian government and maintains that its COW protects it from any new taxes, duties, or fees except for the ones that were part of the initial contract. The company is working with the Indonesian government to find a resolution and remains confident that it will reach an agreement soon. Newmont, on the other hand, has gone a step further and has threatened to take legal action.

If a resolution does not occur in May, Freeport-McMoRan may defer about 50 million pounds of copper and 90,000 ounces of gold per month. Additionally, if this situation continues for an extended period, the company intends to implement a strategy to reduce operational costs, which could mean drastically reducing production. In addition, the company would defer capital expenditures and reduce its workforce.

I believe the Indonesian issue will eventually be resolved with a much smaller impact to Freeport-McMoRan than the market is anticipating. Indonesia has as much to lose as Freeport-McMoRan if an agreement is not reached. Freeport-McMoRan employs thousands of workers in Indonesia and generates significant tax revenue for the country. Indonesia could lose more in tax revenue than it stands to generate from the new laws if Freeport-McMoRan decides to close its operations in the country.

However, I believe it will not come to that and that a mutual resolution will be reached soon. Freeport-McMoRan has a long history of resolving complicated Indonesian issues with much less of an impact than many anticipated.

Bottom line
Despite the unresolved Indonesian issue, Freeport-McMoRan continues to post strong results. The results show the overall resiliency in the company's profitability considering the significant ongoing challenges at Grasberg. Freeport-McMoRan remains one of the most underappreciated stories in the North American mining sector. The company's shares have upside potential as the company executes on its production growth and deleveraging targets.

For investors who can look beyond the near-term uncertainty in Indonesia, Freeport-McMoRan offers a compelling long-term investment opportunity. Post its energy acquisitions in 2012, Freeport-McMoRan is a much more diversified company than it used to be and has ample firepower to continue to withstand the ongoing challenges in Indonesia. The negotiations with the Indonesian government continue, and the company remains optimistic that it will reach a resolution soon; in the meantime, Freeport-McMoRan continues to offer investors a healthy dividend yield of 3.7%.

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