Freeport-McMoRan's Management Believes Copper Could Be Headed Higher

Copper miner Freeport-McMoRan (FCX 2.40%) is an attractive way for investors to benefit from rising raw material prices. In its most recent earnings report, management highlighted several reasons to invest in Freeport. Let's take a look at what was said and why investors have cause for optimism over Freeport-McMoRan.

All about copper 

The prospects for a mining company are largely determined by the price of materials. This is because higher prices usually mean more revenue, provided production remains at least at the same level as previously. But, of course, commodity prices are a product of the interplay of supply and demand.

Image source: Getty Images.

With this in mind, it's worth noting that the four points below touch upon ongoing industry demand and potential supply constraints -- which are usually good for prices. In addition, Freeport has exciting potential to expand production. And finally, investors are likely to see substantially increased earnings and dividends from the company in the future.

1. Demand remains strong

Many investors see copper as the most economically sensitive metal and an excellent way to play a bullish view on global economic growth. And the emergence of a literally electrifying economy promises long-term demand growth.

As CEO Richard Adkerson noted on the recent second-quarter earnings call, most copper is used in "generating and transmitting electricity," with the metal being "critical in every aspect of achieving low carbon goals for the global economy." So whether it's in electric vehicles (wiring) or solar and wind energy (generation, transmission, and storage), the emergence of new sources of demand for copper is important. It's also meaningful because it helps diversify demand away from being primarily a story about growth from China and the rest of the developping world.

2. Supply side considerations

There are two key points of note here. The first is the potential for industry supply constraints in the future. As Adkerson noted, "40% of today's copper supply comes from Chile and Peru," and there's speculation that both countries' governments are looking to increase taxation rates on royalties for producing copper. That's not great news per se, as Freeport has operations in both countries.

Image source: Getty Images.

On the other hand, Freeport expects to generate just 27% of its copper volume from South America (North America is forecast to produce 38% and Indonesia 35%), so it's relatively underexposed. Moreover, Adkerson said the uncertainty around the political developments caused a delay in Freeport's decision over a mine expansion. Suppose the uncertainty also causes others to do the same. In that case, it's likely that industry copper supply could be restrained. That's bullish for prices and miners like Freeport with substantive assets outside South America.

The second point is that Freeport has derisked its production -- this is in contrast to the other major U.S. listed copper play Southern Copper, which is set to enter a multi-year investment phase. Referring to Freeport's major Grasberg area projects in Indonesia and the plan to expand production, Adkerson noted, "there was always an overhang for report related to execution risk with this underground development, political risk in Indonesia." The good news, he says, is "we have met and mitigated all of these major risks that were overhanging our company," and he expects Freeport to reach 100% of the planned production ramp up by the end of 2021.

3. New technology can expand production

On top of expanding production capacity, management discussed the potential to use new leaching technology (a chemical process that extracts copper from already mined material) to increase production.

Management estimates there are 38 billion pounds of copper contained in the stockpiles, and Adkerson said recovering "just 10% to 20% of this material, it would be like having a major new mine with variable capital and operating costs." Those are significant figures considering that Freeport's planned copper production in 2021 is 3.85 billion pounds.

It's early days, but Freeport has a team of leading experts working on the technology. That's something to look out for in the future.

4. Earnings and dividends

The increase in the price of copper over the last year means Freeport is set to significantly increase its earnings before interest, taxation, depreciation, and amortization (EBITDA) in 2021 and beyond. As you can see below, Wall Street analysts have Freeport generating $10.5 billion in EBITDA in 2021 compared to $4 billion in 2020. Moreover, based on a price of copper ranging from $4 a pound to $5 a pound (the current price is around $4.48 a pound), management sees EBITDA at $12.5 billion to $17 billion in 2022 and 2023.

Data source: Freeport-McMoRan, marketscreener.com.

The increase in earnings and cash flow is likely to result in increased payouts to shareholders. CFO Kathleen Quirk said the board was considering its policy, and that "we do expect that we will be following the policy that we'll be paying out up to 50% of the excess cash flow."

Looking ahead

Suppose Adkerson is right about copper demand remaining strong, the supply being constrained, and Freeport's investment in leaching technology paying off. As a result, investors can expect dramatically increased earnings and dividends in the coming years.