Freeport-McMoRan Copper
& Gold’s Indonesian exports are halted as the company awaits its
administrative permits for 2014 exports, which have been delayed as a result of
the new export regulations. The deferral of copper and gold shipments out of
PTFI pending greater clarity over Jakarta’s proposal for a progressive export
tax may weigh on the stock in the near term. It is true that the copper
concentrate exports out of Indonesia are an important EBITDA contributor and
could be a drag on valuation in the near-term, however, the long-term growth
and deleveraging story remains intact.
Driven by lower than
expected mining net costs, the company reported 4Q13 adjusted EPS of $0.84
beating consensus estimates of $0.80 by an impressive 5%. The company also
raised its 2014 energy volume guidance by 7% to 61 mmboe. In addition, the 2016
guidance for copper and oil & gas production also exceeded expectations.
The Indonesian risk is
nothing new for FCX; in fact, there has hardly been a time when FCX traded
without the Indonesian risk factor. As Peter Ward, an analyst at Jefferies,
recently wrote in his report, “We don’t ever recall a time when investors were
very comfortable with Indonesia risk,” said Ward. He further added, “we feel
confident predicting that a strong comfort level is highly unlikely for the
foreseeable future. That said it is very important to remember that FCX is no longer
a one asset company.”
Fundamentally, FCX remains
strong. The company is continuing its path of strong execution and despite a
cautious outlook for copper and gold prices, we believe FCX shares have further
upside potential as the company executes on its deleveraging targets,
production growth plans, and possible value-enhancing MLP opportunities in the
oil & gas segment.
The company reported better
than expected 4Q13 results and 2016 production guidance, but as mentioned
earlier, the Indonesian uncertainty could be a drag on the valuation in the
near-term. Although the explicit protections in the Freeport Contract of Work
protect the company from progressive export taxes, the market may still apply a
lower multiple given the near-term risk to 2014 shipments. On the other hand, a
disruption in copper concentrate shipments could have a positive effect on
prices.
The company remains
confident that it will reach an agreement with the Indonesian government, as is
evident in its steady ramp-up at DOZ underground mine. An agreement should
result in a share price appreciation and focus would shift to 2015-16 growth.
However, in the wake of uncertainty, the company has made changes to its
Grasberg mine plans that will result in the deferral of 80,000 gold and 40
million pounds of copper per month, which if annualized equals ~65% of LME
inventories.
We believe the Indonesian
issues will be resolved with relatively small impact to Freeport as a whole
than what the market is forecasting. It is important to note that FCX has
significant bargaining power and a long history of resolving sticky Indonesia
issues with meaningfully less impact than what the bears suggest. Keeping
Grasberg operating is not only in the interest of FCX but also of Indonesia.
Grasberg generates significant tax revenue for Jakarta and it is an important
local employer (24,000 direct employees). More importantly, Grasberg is a
significant barometer for future foreign direct investment opportunities within
the country. Similarly, in the worst case scenario, if FCX decides to scale
back operations or completely shut down Grasberg, Indonesia has more to lose
than Freeport. The Asian country could lose significantly more future tax
revenues than it stands to gain from implementing new concentrate export taxes.
Major mining companies might also avoid future investments in Indonesia, a
scenario that Jakarta would highly like to avoid. Finally, there are also risks
of major labor disruptions, and labor disruptions have historically been very
unpleasant in Indonesia, again a situation which the Indonesian government
would like to avoid.
On the other hand,
Freeport-McMoRan is a much different company than it used to be pre Phelps
Dodge and PXP/MMR acquisitions. The company can be meaningfully more flexible
now in terms of how and where it deploys its future capital. The old FCX,
before the acquisition of Phelps Dodge in 2007 and Plains/MMR in 2012, was a
heavily levered, single mine company. It depended almost entirely on Grasberg
output. Following the acquisitions, Grasberg’s total output now represents
20%-25% of Freeport’s total copper production. The percentage is expected to
decline further in the coming years, particularly after 2016, as volumes are
expected to increase elsewhere while beginning in 2017 Indonesian volumes are
expected to decline. However, it does not mean that Grasberg is no longer
important to Freeport, but it is not as significant as it once used to be to
the whole company. So again, keeping Grasberg in operation is in the interest of
both parties.
Risks
Apart from the political
risk discussed in the article, prolonged labor unrest in Indonesia provides a
potential risk to our thesis on FCX. Commodity price fluctuations and
disappointing oil & gas exploration results are a few other risks that
could adversely affect FCX’s share price.
Conclusion
Compared to its peers, FCX
shares appear cheaper at spot commodity prices. The company is looking at a
multi-year volume driven growth largely outside of Indonesia. Despite the
Indonesian overhang, we believe FCX’s long-term story remains intact and in the
North American metals and mining sector, it remains one of the most
underappreciated stories. Freeport’s shares remain undervalued and
underappreciated following the company’s controversial 2012 decision to
diversify its operations. The share price should benefit from significant
volume growth across its portfolio of assets. The Phoenix, Arizona based
company could unlock further shareholder value by creating an MLP for some of
its onshore energy assets. Finally, for dividend investors, Freeport also
offers a high dividend yield of 3.8%.
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