The latest earnings report from Freeport-McMoRan (FCX -1.70%) highlighted the investment case for copper, particularly for the miner. A combination of solid and thematic demand drivers (the need for electrification in the economy), industry supply constraints, and Freeport's favorable production outlook make it the go-to stock for investors in the sector. Here's why the stock is worth picking up on a dip.
The case for Freeport-McMoRan
Investing in mining stocks is an odd and always cyclical affair. The price of a metal -- in this case, copper -- is set by the interplay of supply and demand. Therefore, if you invest in miners over the long term, you must be prepared for inevitable fluctuations.
Image source: Getty Images.
That said, the case for Freeport-McMoRan stock rests on the idea that long-term demand is growing while there are increasing signs of potential supply constraints in the industry in the near term.Both trends are positive for the price outlook. Moreover, Freeport sits well placed with relatively less exposure to higher risk countries like Chile and Peru and growth opportunities in key assets in places like Indonesia and the U.S.
Turning to the specifics of how this is relevant for Freeport right now, here are a few summary points from management's presentations regarding its core copper market:
- Long-term demand support from the electrification trend (electric vehicles, renewable energy, automation, smart buildings, connectivity, etc.) and economic growth as copper is the most economically sensitive metal.
- Supply and scarcity issues due to a reluctance to issue permits on environmental and other grounds and political risk in key producing countries like Chile and Peru delaying investments.
- Freeport is relatively less exposed to Chile and Peru, has exciting growth prospects in projects in North America and Indonesia, and has a favorable production profile for the coming years.
Thus, the bull case for the stock rests on the idea that there will be upward pressure on long-term prices, and Freeport can take advantage due to its reserves and production profile.
Long-term demand
Demand won't grow in a straight line, as economic growth never does. Therefore, demand for copper is always primarily correlated with the economy due to its use in construction, electrical networks, consumer products, transportation, and machinery. Thus, marginal changes in demand from China used to be seen as the swing factor in determining demand.
However, Freeport's CEO, Richard Adkerson, sees global growth outside of China as becoming more important for demand in the future,particularly from the move to decarbonize the global economy. Electric vehicles and renewable energy use four to five times more copper than do internal combustion engines and fossil fuel generation. In addition, investors shouldn't underestimate the vast investments coming in 5G and smart connected buildings and infrastructure.
Supply issues and Freeport-McMoRan's favorable position
While the demand side applies to all copper miners, Adkerson sees Freeport as advantaged in terms of supply considerations and production. There are three points to consider.
First, thanks to the success of its development investments in mines in Indonesia and Arizona, Freeport is set to significantly ramp its copper sales in the coming years.
Data source: Freeport-McMoRan presentations.
Second, discussing production in 2022 on the earnings call, CFO Kathleen Quirk said, "We estimate about 36% will come from the U.S., 27% from South America, and about 37% from Grasberg" in Indonesia. Freeport's production in South America is in Chile and Peru -- countries responsible for 40% of global output. Both countries are in the process of political change, and Adkerson noted that they have leaders "who run on agendas that are oriented toward social programs that require more revenues to implement and how the industry and the governments deal with that will be very important."
Therefore, the instability is creating unfavorable conditions for investment, and Adkerson noted that he " We would be moving more aggressively right now" with investment in the El Abra mine in Chile if it wasn't for the political uncertainty in the country. As such, he is looking to "get some clarity from the government in Chile."
However, given Freeport's relative underexposure to Chile and Peru, it's well placed to ride out the instability that could hurt industry supply. Moreover, it's understandable that the stock outperformed a rival like Southern Copper over the past year. The latter has 41% of its copper in open mine pit ore reserves in Peru.
Image source: Getty Images.
Third, management has production growth opportunities, notably in Grasberg and at mines in Arizona. In addition, Freeport continues to work on developing leaching technologies (extracting copper from existing stockpiles), and management is aiming to recover 100 million to 200 million pounds of copper through it.
A stock to buy
Freeport's stock will inevitably bounce around in response to sentiment on the global economy and near-term copper prices, so bear that in mind. However, the long-term demand growth prospects look excellent, and Freeport is well-positioned to benefit from a problematic industry supply situation in the coming years. In this context, it deserves a place in a long-term investor's portfolio.
