Companies like Freeport-McMoRan (FCX, Financial) and Teck Resources (TECK, Financial) gained considerably in 2016 in spite of some key challenges in the industry.
Company overview
Freeport-McMoRan is a natural resources company that operates large long-lived geographically diverse assets. Its portfolio of metal assets includes the Grasberg minerals district in Indonesia, one of the world's largest copper and gold deposits. It also has significant mining operations in the Americas, including the large-scale Morenci minerals district in North America and the Cerro Verde operation in South America. This makes Freeport-McMoRan one of the largest producers of copper next only to Codelco.
The company currently has 2P reserves of 87 billion pounds with 102 billion pounds of mineralized material and 156 billion pounds of potential resources with North America being the largest contributor.
Performance catalysts in fiscal 2016
In the financial year 2016, the company gained almost 95% and as of Dec. 31, 2016, Freeport-McMoRan was trading at $13.19. This upward price trend was a relief for its investors as the company along with other miners witnessed their worst financial year in 2015 after the 2008-2009 global financial crisis. However, in 2016, miners witnessed an upward price movement. And companies like Teck Resources and Glencore (LSE:GLEN) (GLNCY, Financial) gained 557% and 156% in the same year.
Some of the things that were positive factors for Freeport-McMoRan were sale of its assets, Donald Trump’s win in the U.S. presidential election and stability in crude oil prices.
The company sold 13% ownership of its interest in its Morenci mine to Sumitomo Metal (TSE:5713, Financial) for a consideration of $1 billion. Post the sale announcement the stock rose by 15%, which indicates a positive response by its investors. In order to raise cash and de-lever its balance sheet, the company had several copper and energy sales along with the sale of its stake in Indonesia operations. This has resulted in cash inflow of $6.6 billion for fiscal 2016 which has helped the company manage its debt. The sale of assets was received well by the investors, which has translated in an upward price movement.
Trump’s win in the election is another reason for the stock upside. This is primarily because Trump mentioned in his campaign that he intends to spend $500 billion in infrastructure development, twice to what Hillary Clinton had suggested. Investments in infrastructure would boost cement and steel demand and would have a positive impact on the copper industry as well, and it was after his win that copper prices went up to $6,000 per metric ton.
Another reason for the copper price rise was stability in crude prices. Higher crude prices had a positive impact on market sentiments, and there was a positive correlation in both the crude price rise and copper prices. It was the combined effect of the above mentioned catalysts that Freeport-McMoRan witnessed a 95% rise in its stock prices in fiscal 2016.
Stable financials with improving balance sheet
In fiscal 2016 the company had $4.65 billion in copper sales, $1.1 million in gold sales and $74 million of molybdenum. And in fiscal 2017 the company expects to further increase its sales of gold and molybdenum to $2.2 million and $92 million. This would boost the company’s revenue growth which along with its cost reduction strategy will have a positive impact on its EBITDA.
In fiscal 2016, Freeport-McMoRan managed to cut down its cost by around 19% as compared to fiscal 2015. The graph below indicates that net unit cash cost decreased from $1.53 in fiscal 2015 to $1.26 in fiscal 2016. Free cash flow also improved due to increasing operating cash flow and a decline in total capex in fiscal 2016.
For fiscal 2017, the company expects an operating cash flow of approximately $4.3 billion and a capex of $1.8 billion. This would bring the company’s free cash flow to $2.5 billion, 177% rise over fiscal 2016. The excess cash can be used to create shareholder value though dividends and share repurchase.
Looking at the company’s balance sheet, Freeport-McMoRan considerably reduced its net debt by $8 billion in fiscal 2016 from a high debt of $20 billion. The decline in its debt would also relieve the company from the burden of rising interest rates and would further strengthen its balance sheet.
As discussed, the decline in debt is mainly due to the sale of its assets and a refocused strategy to retain a high quality copper portfolio. For the financial year the company further expects to decrease its debt to around $8 billion from $11.8 billion at the end of fiscal 2016. This decrease would depend on the varying copper prices and is expected to decrease with rise in its price.
Valuation
Freeport-McMoRan is trading at an attractive estimated fiscal 2017 and fiscal 2018 price-earnings (P/E) of 12.6 and 10.8. Also, with a five-year expected PEG of 0.3 the company looks undervalued. In terms of EV/EBITDA, Freeport is trading at fiscal 2017 and fiscal 2018 estimated EV/EBITDA of 5.5 and 4.7. Thus considering all the valuation multiples of Freeport-McMoRan, the company is attractively valued and has the potential to outperform in 2017.
Conclusion
Freeport-McMoRan is one of the mining companies that performed well in fiscal 2016 along with Teck Resources and Glencore. However, since Teck and Glencore gained 557% and 156% in fiscal 2016, Freeport-McMoRan has a better chance to outperform in this financial year. Also, considering its refocused strategy of building valuable copper assets and an attractive valuation, Freeport-McMoRan can be considered a good long-term investment.
Disclosure: No positions in the stocks discussed.
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