Investment overview
Freeport-McMoRan Inc.'s (FCX, Financial) stock price has witnessed a volatile 2017. From a high of $17 on Jan. 24, the stock slumped 34% to $11.2 by June 21. Subsequently, the stock has moved 38% higher and currently trades at $15.5.
Since the current upside is sustainable, I believe Freeport-McMoRan can be considered a hold and a potential buy on any correction in the foreseeable future.
Positive trend in copper prices
For Freeport-McMoRan, the copper segment remains the key driver of EBITDA and cash flow. When the stock price slumped, the primary reasons were declines in copper, oil and gas prices and high leverage.
While the company has been working on deleveraging and oil prices have remained in a narrow range, it is encouraging to see copper trend gradually higher.
With copper near $3 per pound, the recent surge is not surprising. It is important to note that as copper prices were depressed, the mining industry witnessed a sharp slowdown in investments.
As a result, I do not expect strong growth in supply, which is likely to ensure copper prices remain stable in the coming quarters. Copper is considered a leading indicator of global economic activity. If this holds true, sustained economic growth can translate into copper prices remaining well above $3 per pound in the coming quarters. In particular, strong demand from China and India will continue to drive copper prices higher.
Therefore, from a commodity price perspective, the outlook for Freeport-McMoRan is positive. I expect this to translate into higher cash flows in the coming quarters.
To put things into perspective, in the first half of the year, Freeport-McMoRan reported operating cash flow of $1.8 billion and free cash flow of $1.1 billion, with a realized copper price of $2.65 per pound. With copper prices expected to be well above those levels in the second half of the year, strong free cash flow generation is likely.
Improving fundamentals
As mentioned earlier, one of the key challenges Freeport-McMoRan faced in 2015 was leverage. At that time, the company’s net debt totalled $20.1 billion and commodity prices were depressed.
Through asset sales, the company has reduced debt considerably. As of June 30, the company’s net debt has declined to $10.7 billion.
For the first half of the year, Freeport-McMoRan reported positive free cash flows. If copper prices average $3 per pound in the second half, the company expects debt to further decline to $9.2 billion. Even at a price of $2.75 per pound, the company’s debt is likely to decline to $9.6 billion.
The main conclusion here is fundamentals are likely to improve over the next several quarters. if copper prices sustain above $3 per pound, Freeport-McMoRan is well positioned to reduce leverage as well as accelerate investments in key assets.
Therefore, I do not see any balance sheet concerns for fiscal 2017. I expect the focus to be on capital investments as copper prices solidify.
Progress of Indonesian assets
Through its 90.64% owned and consolidated subsidiary PT-FI, the company operates one of the world's largest copper and gold deposits in Indonesia's Grasberg minerals district.
One of the major factors impacting Freeport-McMoRan this year is new regulations issued by the Indonesian government related to mining stakes, taxes and royalties. With uncertainty on that front, the valuation has been negatively impacted.
Regardless, it is worth noting the dispute has not only impacted Freeport-McMoRan, but also the Indonesian government from a royalties and tax receipts perspective.
On Aug. 22, Reuters reported Indonesia is expected to enter an agreement with Freeport-McMoRan. Once this happens, I expect the stock to move higher. Therefore, with resolution finally in sight, fresh exposure to the stock can be considered.
Conclusion
Copper is considered to be a leading indicator of global economic activity. With the commodity trending higher, it indicates the worst might be over for emerging economies (that drive copper consumption demand).
This is good news for Freeport-McMoRan as cash flows can potentially swell over the next several quarters. As the company reduces debt and makes robust investments, the stock has the potential to move higher.
Disclosure: No positions in the stock.
