Valuentum Exclusive Analysis for the Discerning Investor

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Image Source: Freeport-McMoRan Inc – February 2020 IR Presentation

By Callum Turcan

Global copper, gold, and molybdenum miner Freeport-McMoRan Inc (FCX) suspended its quarterly common dividend in March 2020 and provided a revised outlook for the full-year in April 2020 due to the coronavirus (‘COVID-19’) pandemic hampering both commodity prices and its operational performance. One of those hurdles involved the Peruvian government imposing restrictions on its Cerro Verde mine in March 2020 (as part of COVID-19 containment efforts), a copper mine that Freeport-McMoRan owns a ~54% stake in. Another hurdle involved the collapse in commodity prices earlier this year (though gold prices have held up quite well in 2020). First, let us provide some background before highlighting why Freeport-McMoRan’s outlook has recently improved considerably.

Background

In April 2020, the miner significantly reduced its outlook for its copper and molybdenum production this year from guidance given out in January 2020 (while marginally boosting its forecast for its gold production this year). The firm’s April guidance forecasted that Freeport-McMoRan’s copper, gold, and molybdenum production would fall in 2020 versus 2019 levels, even after considering the marginal increase in its expected gold production versus previous estimates.

To offset the negative impact of COVID-19, Freeport-McMoRan aggressively reduced its capital investment expectations for 2020 in April while also announcing plans to reduce its operating costs and corporate overhead expenses. These cost saving strategies targeted $0.1 billion in savings from reduced exploration and administrative expenses, a $1.3 billion reduction in its operating expenses (keeping lower total forecasted production volumes in mind) and scaling back its 2020 capital investment expectations by $0.8 billion. In our view, these measures were required considering the miner exited March 2020 with a net debt load of ~$8.5 billion (cash and cash equivalents less short-term debt less current portion of long-term debt) and given that the firm was expecting its cash flows to come under intense pressure.

Outlook Update

Very recently, Freeport-McMoRan reported that its mining operations and developments had been progressing better than feared. Copper prices have been relatively strong of late, assisted by fiscal stimulus measures in China and the potential for supply disruptions in Chile, while gold prices have been steadily climbing year-to-date, supported by very dovish monetary policies worldwide (including policies enacted by the US Fed). Freeport-McMoRan noted stronger copper prices in the second quarter on a sequential basis would improve its financial performance versus previous assumptions during a July 6 press release. Here is a key excerpt from that press release highlighting its improving operational and financial outlook (emphasis added):

FCX’s 2020 revised operating plans are focused on safeguarding its business in an uncertain public health and economic environment, advancing the ramp-up of underground production at Grasberg to establish large-scale, low-cost copper and gold production, and advancing initiatives in the Americas to position FCX for significant increases in cash flows in 2021 and beyond.

During the second quarter, FCX met or exceeded several key performance targets included in its April 2020 revised operating plans. Second-quarter 2020 copper sales are expected to exceed the April 2020 estimate of 690 million pounds by approximately 8 percent and gold sales are expected to exceed the April 2020 estimate of 165 thousand ounces by approximately 10 percent.

With that in mind, the Cerro Verde mining operation has performed in-line with Freeport-McMoRan’s April 2020 guidance through early-July. Outperformance came from Freeport-McMoRan’s Indonesian operations. Freeport-McMoRan owns a ~49% stake in the PT-Freeport Indonesia (‘PT-FI’) joint venture (with the Indonesian government owning the remaining stake), though its economic interest in the venture sits at ~81% through 2022 due to a complex transaction involving the Indonesian government, Freeport-McMoRan, and Rio Tinto plc (RTPPF) that was completed in December 2018.

What makes PT-FI venture important is the Grasberg minerals district is in Papua, Indonesia, which is home to a massive gold and copper mine. In 2019, PT-FI commenced commercial mining operations at the Grasberg Block Cave underground mine after completing open pit mining activities the same year. Additional resources are being recovered from the Deep Mill Level Zone (‘DMLZ’). Here is another excerpt from Freeport-McMoRan’s July 6 press release (emphasis added):

Significant progress was achieved at Cerro Verde during the second quarter to restore operations following COVID-19 restrictions imposed by the Peruvian government in March 2020. Strict health protocols have been implemented and a plan for Cerro Verde was approved by the Peruvian government in second quarter 2020. During June, Cerro Verde mill operations averaged 315,000 metric tons of ore per day, approximately 80 percent of the 2019 annual average. Cerro Verde’s operating rates are in line with the April 2020 operating plan…

…The ramp-up of underground production at the Grasberg minerals district in Indonesia continues as-planned. During the second quarter, combined production rates from the Grasberg Block Cave and Deep MLZ (DMLZ) underground mines exceeded 54,000 metric tons of ore per day, approximately 9 percent above the April 2020 estimate and 46 percent above the first-quarter 2020 average.

At the end of June 2020, combined production from the Grasberg Block Cave and DMLZ averaged approximately 70,000 metric tons of ore per day. PT Freeport Indonesia expects its 2021 copper and gold production to approximate 1.4 billion pounds of copper and 1.4 million ounces of gold, nearly double projected 2020 levels.

We appreciate that Freeport-McMoRan has been able to resume mining operations and mine development activities in earnest. A combination of stronger commodity prices and better than expected production figures (versus guidance given out in April 2020) has considerably improved the miner’s near-term cash flow outlook.

Freeport-McMoRan expects to commence production at its Lone Star copper leach project in Arizona soon as the development remains “on track to produce approximately 200 million pounds of copper per annum beginning in the second half of 2020.” The Lone Star development is wholly-owned by Freeport-McMoRan and bringing commercial mining operations online should further enhance its cash flow outlook.

Balance Sheet and Liquidity Update

Freeport-McMoRan continued to carry a large net debt load as of early-July 2020. This upcoming excerpt is from its July 6 press release (emphasis added):

At June 30, 2020, FCX had no amounts drawn under its $3.5 billion revolving credit facility. At June 30, 2020, total consolidated debt is estimated to approximate $9.9 billion and consolidated cash is estimated to approximate $1.5 billion.

The 2020 financial estimates in this press release are based on modeled results and subject to further changes upon completion of FCX’s normal closing process and finalization of quarterly financial and accounting procedures.

Generating positive net operating cash flows going forward would be a significant improvement from its weak first quarter performance, when Freeport-McMoRan generated negative operating cash flows and thus negative free cash flows. Freeport-McMoRan’s liquidity position appears solid as most of its $3.5 billion revolving credit facility does not mature until April 2024 (~$3.3 billion matures in April 2024, ~$0.2 billion matures April 2023), granting the miner access to liquidity during these harrowing times (on top of its sizable cash position). The miner would be well advised to cut down on its net debt load over the coming years, if able to do so, in order to improve its long-term financial trajectory and flexibility.

Concluding Thoughts

While most miners (outside of pure play gold miners) came under intense pressure during the first several months of 2020, things are beginning to turn around. Shares of FCX surged by almost 11% on July 6 during normal trading hours after the miner published its update. That being said, Freeport-McMoRan still remains exposed to a second wave of confirmed COVID-19 infections in the event quarantine efforts are imposed again in key economies around the globe. To read more about the ongoing rebound in the mining sector, check out our latest article covering BHP Group (BHP) (BBL) through this link here---->>>>

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Callum Turcan does not own shares in any of the securities mentioned above. Newmont Corporation (NEM) is included in Valuentum’s simulated Dividend Growth Newsletter portfolio. Both the simulated Best Ideas Newsletter and Dividend Growth Newsletter portfolios include a SPDR S&P 500 ETF Trust (SPY) put option holding with a $295 per share strike price that expire on August 21, 2020. Some of the other companies written about in this article may be included in Valuentum's simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.