The latest results from copper miner Freeport-McMoRan (FCX -1.87%) helped highlight the stock's investment case. As with all commodity-based cyclical stocks, it's usually great news for earnings when the commodity's price is soaring. Indeed, a 40% year-over-year increase in the average realized price of copper led to a whopping 210% increase in adjusted earnings before interest, taxation, depreciation, and amortization (EBITDA) to $3 billion in the quarter.
The question is: Can it continue, and is the miner well positioned to take advantage? Here are three reasons why the answer is "Yes."
Demand for copper
As usual on the earnings call, CEO Richard Adkerson outlined the positive prospects for the demand side of the equation, and he has good reason for doing so. Replacing internal combustion engine (ICE)-powered vehicles with electric (EV) or hybrid electric vehicles implies a marginal increase in demand for copper. EVs typically require two to four times the same amount of copper (primarily in the extra needed wiring) as ICE vehicles.
Moreover, growth in the use of renewable energy implies investment in the transmission and distribution networks necessary to carry electricity and storage capability.
While these two long-term demand drivers attract attention, it's essential not to forget the general trend toward electrification in the economy. The growth of new technologies such as 5G, artificial intelligence, the Internet of Things, and smart technologies imply significant investment in electrification. Simply put, an increase in the use of those technologies will make electrification financially attractive. That's the case whether it's in the developed or developing world.
As Akerson noted on the earnings call when talking about demand, "all of the investments that people are going to be making to reduce carbon" will result in significant copper demand.
Supply conditions will remain tight
Turning to the other side of the equation, Adkerson believes the supply side conditions are also favorable, pointing out that copper inventories are currently at a "47-year low." Thus, while new copper production would come "on stream in the next couple of years," the "cupboard is pretty empty in terms of new supply projects of any significance."
Meanwhile, "[regulatory] permitting still requires a very long period of time," and political uncertainty in key copper-producing countries like Peru and Chile may be holding back investment in new sites.
Freeport-McMoRan is well positioned
In such circumstances, it's critically important for the miner to be in a position to expand its production to take advantage of higher copper prices. As such, investors were pleased to hear that Freeport-McMoRan plans to increase copper volume by 20% in 2021 and then a further 15% in 2022. Moreover, expansion projects on existing sites in Arizona, Chile, and Indonesia will lead to a ramp in production in the coming years.
In addition, Adkerson discussed the company's ongoing development of leaching technology (chemical processes that extract copper from existing stockpiles of mined material). He argued that the miner has 40 billion pounds of copper in stockpiles, and if a small percentage of it is recovered, it would be the "size of a new mine." For reference, management forecasts copper sales volume will be 3.8 billion pounds in 2021.
All told, the company stands to benefit well from an elevated price of copper.
A note of caution
Anyone discussing a cyclical stock must also consider the downside, and there are genuine near-term considerations here. It's no secret that China's construction market is under pressure, and a slowdown in construction activity could reduce demand. Furthermore, the global economy is facing much-documented supply chain issues that are causing companies to hoard raw materials like copper, as they fear potential supply issues.
Finally, the economy is recovering after the lockdowns in 2020, and demand might cool off in 2022 as year-over-year growth slows and supply chain issues ease.
All told, there are reasons to believe the price of copper could moderate in 2022, and that could take Freeport-McMoRan's earnings expectations down with it.
A stock to buy?
On balance, Freeport-McMoRan is an attractive stock to buy and a great way to play a positive outlook on copper. That said, it needs to be bought with a long-term view in mind as history suggests commodity prices oscillate around a trend. Thus, investors will hope that Adkerson is right and the long-term trend will be an upward-sloping one.