Freeport-McMoRan slump: time to buy?
Investors didn’t hear what they wanted from the copper miner Freeport-McMoRanit is (FCX -3.08%) Presentation of first quarter results. The main problem came from the forecast: the short and medium term sales prospects are down and the short term costs are increasing. As such, it’s no surprise to see the stock tumble more than most in the latest market sell-off. So is this a buy opportunity, or does the shift in focus have a material impact on the investment thesis? Let’s take a closer look.
The case of Freeport-McMoRan
As a reminder, the investment case for Freeport-McMoRan is based on the idea that the demand for copper is increasing due to the underlying industrial demand associated with its increased use in electric vehicles, renewable energies and the trend towards electricity. electrification of the economy. Meanwhile, on the supply side, increased regulations and political opposition to new projects are seen as reducing overall industry supply. However, Freeport-McMoRan’s relatively strong position – significant production assets in the United States and Indonesia and opportunities for expansion – puts it in a relatively stronger position.
In short, the outlook for copper prices is good and Freeport-McMoRan is well positioned to benefit from it with its production capacity.
Unfortunately, this thesis has recently taken a hit due to management lowering its copper sales estimate for 2022 and 2023 (in terms of copper volume) and increasing its cost assumption for 2022 due rising energy and raw material costs.
Starting with the reduced sales volume forecast, this mainly comes down to limited mining rates due to the COVID-19 outbreaks in the first quarter. Copper sales in the first quarter were significantly higher than expected at 1,024 million pounds compared to guidance of 970 million pounds, but as Chairman Kathleen Quirk said on the earnings call, “We have benefited from strong US demand during the quarter, which allowed us to reduce inventory.” However, you can only rely on inventory for so long, and management lowered its sales volume estimates for each future quarter of 2022 in the presentation of the results of the first quarter.
It’s getting worse. Management also raised its cost forecast for net unit cash costs in 2022 from $1.35 to $1.44. A breakdown of business cost components shows that materials and supplies account for 32%. Energy accounts for 21%, so there is no doubt that the miner is exposed to a general rising energy tide and further commodity price increases. .
The market doesn’t want to hear about falling sales volume expectations and rising costs, and at the time of this writing, the stock is down nearly 20% since the earnings release. . This represents a whopping $13.7 billion reduction in market capitalization.
A buying opportunity?
The question then becomes whether the sell is overdone and whether the stock represents a good value opportunity. I think the answer to both questions is yes. There are three reasons for this.
First, the reduction in sales volume is estimated at 100 million pounds combined over 2022 and 2023. Using management’s assumption for the copper price in 2022 of $4.75 per pound, this equates to 475 million pounds. dollars. Assuming an operating profit margin of 40%, this represents a shortfall of $190 million. Wiping $13.7 billion off the market capitalization due to $190 million in “lost” revenue over a few years seems overly dramatic.
Second, the reduction in sales volume in 2022 and 2023 does not mean that Freeport-McMoRan will not eventually achieve these copper sales volumes. It just means that they will come out, because they are due to temporary problems.
Third, it is far from clear that cost increases are not temporary problems that will diminish over time. Indeed, CEO Richard Adkerson and Quirk believe these cost issues are transitory and have been exacerbated by the conflict in Ukraine. For example, energy supply chain dislocations created by sanctions on oil and gas from Russia have been a factor.
A stock to buy
For the reasons above, it’s hard not to think the sale is overdone. However, there are a few caveats worth noting. First, just as the company’s cost increases may prove to be temporary, it is also possible that the current strength in the price of copper may also prove to be temporary. For example, Ukraine is a major exporter of copper wire harnesses for the automotive industry. The war caused dislocations and created increased demand for copper elsewhere.
Additionally, the conflict is also causing many economic forecasters to downgrade global growth expectations, and if that happens, copper demand could moderate as well.
All told, buying the sell makes sense for investors who continue to believe in the long-term case for copper and a scenario of continued economic growth, albeit with some temporary supply chain disruptions caused by events in Ukraine.