It's been hard for Freeport-McMoRan (FCX 2.40%) to catch a break. The year started off with Indonesia hiking taxes and royalty rates on unprocessed ore shipped out of the country to such an extent that both Freeport and Newmont Mining suspended mining work in the country, complaining the impositions violated long-standing contracts with the government.
The spoils of war: Freeport's rich Grasberg mine. Image: Wikimedia Commons.
Freeport eventually caved in to the government's demands, even though it wrangled somewhat lower royalty rates, and a memorandum of understanding between the two sides meant it could restart its operations again.
At the time of the announcement, the government said it anticipated Freeport's exports would total some 756,300 tons of copper concentrate through the end of the year, about half the total the country exported for all of 2013. And though Freeport itself doesn't quantify the concentrates it exports, it did produce about 400,000 tons of copper in Indonesia last year, up 24% from 2012.
With the biggest logjam to its operations removed, there's good reason to believe its stock can move higher again. Here are three of the biggest reasons Freeport-McMoRan stock might see gains coming in the future.
1. Copper production and pricing
Copper prices that rallied in late 2013 to about $3.35 per pound have given up much of their gains and now trade at around $3.13 per pound, well off the $4.50 peak price hit in 2011 and analysts fear adding more inventory to the market could weaken prices further. However, anything above $3 a pound still puts Copper well above where it was more than a decade ago.
Freeport anticipates its cash costs for copper production this year at just $1.54 per pound, meaning it is still exceptionally profitable even with the metal not pricing out at top dollar and can afford to increase let alone maintain its production levels.
Copper LME Settlement Price data by YCharts
Freeport has within its portfolio several mines with world-class potential, particularly at Morenci in Arizona, where it expects the $1.6 billion expansion project to add 225 million pounds of copper annually. The miner believes both Morenci and Cerro Verde in Peru, another project it is expanding, have the potential to produce 1 billion pounds per year.
That would put them in the top-tier of the world's biggest mines. In 2013, Morenci, for example, produced 564 million pounds of copper. More importantly, though, being located in the U.S., the mine gives Freeport far more stability with operations and costs. The workforce there isn't unionized so it has flexibility in controlling labor costs.
It's a similar, if less dramatic, story in Freeport's energy markets, where oil sits below $100 a barrel and natural gas is under $4 per million British thermal units (MMBtu).
Freeport, which purchased both Plains Exploration & Production and McMoRan Exploration as a hedge on its copper and gold production, yet endured investor anger over the seeming "diworisification" of its business, was eventually lauded for its foresight when copper prices collapsed.
However, it does face higher costs in this segment. This past quarter, Freeport said it faced a higher year-over-year cash production cost of $19.57 per barrel of oil equivalent, and it expects that cost to reach $22 per BOE in the back half of the year.
Economic pressures across Europe and now China could mean dampened short-term demand for industrial metals such as copper and energy sources from oil and gas, but the long-term outlook remains bullish.
Notwithstanding the current pricing volatility, there's reason to believe both copper and oil and gas have bright futures. Copper is broadly used in industry and construction, and even though China appears to be going soft, there's still increased urbanization occurring across Asia. Meanwhile, there remains limited supply from existing mines; no new significant development of new sources; and the U.S. economy continues to improve, albeit slowly.
If China gets back on its feet, demand for the metal, and for more energy sources, could reignite.
3. Investments in its business
Freeport-McMoRan is using the global weakness in its key industries to position itself as a premier player in each. The company plans to increase capital expenditures 34% this year to $7.1 billion, then boost that to $7.3 billion in 2015. Even the following year's $6.6 billion in investments would be greater than what was spent in 2013.
Source: Freeport-McMoRan Investor Presentation.
Most of the new spending in the oil and gas sector will be from Freeport's deepwater assets in the Gulf of Mexico. Proceeds from the recent sale of its Eagle Ford shale assets will help pay down the company's sizable debt.
The smart investor's takeaway
Cyclical stocks like Freeport-McMoRan are expected to be volatile, rising and falling with the ebb and flow of the economy, but doing so in more dramatic fashion. During downturns they can suffer substantial losses and growth can look anemic, if not downright absent, yet when the economy turns, their acceleration to growth can be just as startling and the generation of profits can often exceed expectations.
It's counterintuitive to invest when the chips are down, but for cyclical stocks that is the best time to buy. With shares trading at their June levels before the situation in Indonesia was resolved, they're a better value now than then. And because it has a relative valuation superior to industry peers such as Newmont and Southern Copper across a range of metrics, this miner and E&P play looks like it has a bright future.
In short, Freeport McMoRan's immediate outlook seems to suggest weakness, but investors with a longer-term outlook can use its volatility and market softness to their advantage.
