Copper is a key industrial metal, with a price that tends to ebb and flow with global economic activity. Since the start of 2018, copper is down around 9.5%. Copper miners Freeport McMoRan, Inc. (FCX 0.65%) and Southern Copper (SCCO 0.77%), two of the biggest names focused on the metal, are off by roughly 30% and 15%, respectively. That's not surprising given copper's recent weakness.
But if you like the idea of adding this metal to your portfolio, perhaps because you expect economic growth to keep ticking higher, think carefully before you invest here, because the bigger drop may not be the better opportunity. This is what you need to know to decide if Freeport or Southern Copper is the better copper stock.
Well, that didn't work out as planned
In mid-2013 Freeport made a big shift by buying two oil companies. That decision had a massive impact on the company's balance sheet, with long-term debt rising from roughly $3.5 billion in 2012 to roughly $20 billion in 2013. Long-term debt went from a modest 20% or so of the capital structure to a more troubling 50%. That would have been manageable if it weren't for the fact that oil prices fell into a deep bear market in mid-2014. With the drop in oil prices from over $100 a barrel to the $30 range, Freeport's big oil bet suddenly turned into a massive liability.
Freeport made leadership changes and worked quickly to shore up its finances. That required divesting the oil business, taking write offs, eliminating the dividend for a spell, and putting virtually all of its effort toward paying down debt. It has made a great deal of progress, with long-term debt at the end of 2018 sitting at roughly $11 billion. However, long-term debt as a percentage of the capital structure is still roughly 50%. In other words, even after all of that debt reduction, the legacy of the (in hindsight) ill-timed oil investment has left Freeport with a debt-heavy balance sheet and virtually nothing else.
To put it mildly, the oil foray was a disastrous use of shareholder capital. And investors continue to pay for it, since there's still $7.5 billion in debt on the balance sheet (and associated interest expenses on the income statement) that wasn't there before the acquisitions. To be fair, the new leadership team has done an excellent job with a bad situation (and managed political issues at a key Indonesian mine deftly along the way). But that doesn't change the fact that Freeport's balance sheet is in notably worse shape today than it was before that deal.
Check out the latest earnings call transcripts for Freeport McMoRan and Southern Copper.
Focused on copper
Southern Copper didn't make a similar foray, sticking close to its copper roots through the span. Although long-term debt is around 50% of the capital structure today, that's not a material change. The company's debt level in 2012 was roughly $4.2 billion, rising to a little under $6 billion in 2018. An increase to be sure, but not on the magnitude of what happened at Freeport. Looking at leverage in a slightly different way, Freeport's debt to EBITDA ratio is roughly 1.9 times, compared to Southern Copper's 1.7 times.
In other words, unlike Freeport, Southern Copper's game plan never changed. Note, too, that Southern Copper's dividend, while fluctuating along with commodity prices through the period, wasn't eliminated to help it heal from self-inflicted wounds.
There is a much better backstory at Southern Copper, but there are other facts to look at as well. For example, Freeport produces more copper than Southern Copper. However, Southern Copper has larger reserves (management believes it has the largest copper reserves in the world). In the end, this is probably something of a wash: Freeport could acquire more reserves, and Southern Copper could up its production.
However, there is one place on the mining front where there is a notable difference: cost structure. Southern Copper's cash costs came in at just $0.87 per pound in 2018, while Freeport's costs were $1.07. That's a big difference that gives Southern Copper a clear edge.
But there's a directional issue here as well. Southern Copper's cash costs fell around 5% in 2018 and, based on management's projection of $0.80 per pound cash costs in 2019, will fall another 8% this year. Freeport's cash costs fell 10% in 2018, but are expected to rise dramatically in 2019, hitting $1.73 per pound, partly due to investment plans. But the big takeaway is that Southern Copper is able to pull copper out of the ground for less than Freeport, and that's not changing anytime soon.
All in all, Freeport and Southern Copper are both very important global producers of copper. However, Southern Copper's focus on the industrial metal has never swayed, and it has very low production costs. Freeport's foray outside the mining space proved a disaster for investors and has had a lingering negative effect on its balance sheet. Add in the fact that its costs are higher than Southern Coppers' and one of these miners starts to appear a lot more interesting than the other. If you are looking for a way to play copper, you're better off going with Southern Copper. It may not be as exciting as Freeport, but in this case boring looks like it's a good thing.