Freeport-McMoRan Stock: Bold Management Guidance Warrants Taking Some Profits (NYSE:FCX)

Fiscal Year 2024: Aggressive Guidance Update

Freeport’s (NYSE:FCX) management surprised us with upbeat guidance for 2024 above January estimates:

The sales outlook remained similar at 4.15 billion lbs. Still, the site production and delivery costs forecast (a subset of unit net cash cost) has increased from $2.37/lb to $2.40/lb, which is still a bold assessment given that Q1 costs came in at $2.48/lb and projected a slightly higher number for Q2 at $2.52/lb.

Production and delivery cost is the main component of unit net cash costs against which we apply by-product credits, treatment charges, and royalties/export duties. So, they expect a significant efficiency improvement or deflation in input costs in the year’s second half to reach this $2.40/lb estimate.

They also increased their forecasted operating cash flows for 2024 from $5.8 billion, with copper averaging $3.75/lb and gold price at $2,000/oz, to $7.4 billion, driven by an increased estimate of the average copper price for q2 to q4 at $4.25/lb and gold at $2,300/oz. Daring.

CAPEX Changes in Some Discretionary Projects

On the discretionary capital projects, there appeared some changes:

• I find it curious in the company’s presentation that the line under the Grasberg Mill Recovery Project, which projected in the past quarter an incremental copper production of 60 million lbs per year and 40 thousand ozs of gold, has disappeared without giving any new estimate.

• Other minor revisions of the CAPEX estimate that came without any comment are for the Grasberg transition to LNG, from $100 million to $95 million in 2024, and for the Atlantic Copper CirCular project, from $210 million to $190 million for the year.

• The estimated cost of expanding the tailing infrastructure necessary to advance the future expansion to double production has been adjusted significantly from $130 million in the January estimation to $210 million. Also, the estimated capex for the autonomous haulage project in this mine has increased from $55 million to $65 million.

I find it odd that analysts at the conference didn’t mention any of these themes. The only change in estimates management addressed was the projected capex for 2025 of an additional $100 million in discretionary projects, which the upcoming CEO, Kathleen L. Quirk, clarified is due to a timing issue concerning the Kucing Liar project.

Sensitivity Analysis

Let’s take into account the company guidance for the remainder of the year, with copper averaging $4.25/lb and gold at $2300/oz, holding constant the EBITDA multiple, taking as a reference the closing price of April 23, when the new information was incorporated into the price, and taking the Q1 2024 as a reference of an annual EBITDA running rate of 6.67 billion for 2024 (excluding non-controlling interest). We obtain a multiple of 10.4x, much higher than 8.6x at the beginning of the year.

Just returning the copper price to a slightly below average price for the year at $4.15 (remember that its average realized price for Q1 has been $3.94) and the gold price to the previous technical support level at $2,100 would take us back to a target price for FCX of $42.27. If we hold production volumes constant, the market may reprice $825 million less of EBITDA at lower multiples, which would take us to 52-w support levels between $34-$36. That is the nature of a cyclical industry like mining, and when some stock is priced in this upbeat mood, it doesn’t take much to have a significant correction.

Key Themes to Watched in This Earnings

In the previous update, I signaled some key things to watch on the earnings call as possible themes to give more fuel to the current rally:

Improvements in its leaching operations: Following the completion of phase one, it will be crucial to assess any progress in successfully scaling this initiative beyond the initial target of 200 million lbs per year. The next phase aims to achieve an additional incremental production of 200 million lbs/year, bringing the total to 400 million lbs.

The figure for the first quarter is 51 million lbs, so we can assume that the 200 million lbs is viable. Still, the next target to double production is far from achievable this year, as the first phase was the proving concept of applying the leaching technologies on every oxide stockpile possible. However, the second phase was supposed to be the scaling one; on the earnings call, the CEO said that her focus now is on studying new additives that could improve operations. I expect a flatter progression slope if the scaling is almost done. Management forecast for 2024 was to achieve 200 million lbs of production, an increase of 39% from 144 million lbs in 2023. It seems a very plausible target, as we are already there.

The management views this leaching initiative project as having the highest NPV of any project in FCX’s history because of its low cost and high potential.

Updates on the Bagdad expansion and El Abra water infrastructure issues (10-K p.60): Any developments in these areas could indicate the likelihood of new production coming online before 2030.

We get a little pushback regarding these two promising projects. With El Abra, the company aims to file the Environmental Impact Study (EIS) by year-end 2025. In the conference call, the CEO mentioned an 8-year lead time for the project; even an additional review by the regulators could add 2-3 years more.

Therefore, from the 1.7 billion lbs of estimated incremental annual production coming from the Americas’ projects, the 39% bucket of 7-8 years is entirely assigned to El Abra, in an optimistic scenario as the company didn’t mention any solution on the table concerning the water infrastructure issues, and the Chilean regulations has been characterized by long lead times.

The company left 37% in the 3-5-year bucket for the Bagdad project. The management expects to make an investment decision in 2025 depending on several issues: in the call, the CEO repeated several times her worries about labor shortages in a very competitive region, lack of training of the workforce, and reliance on contractors at a higher cost than own workers, as impediments to advance the project. She also hinted that until they don’t have the autonomous trucks efficiently working on the field, giving management the conviction that fewer workers would be needed along with less housing infrastructure, the extension of the mine won’t have the green light.

Also, in North America, the management gave some color on the Safford/Lone Star operation, a project that, beyond the expected increase in leaching stacking rate with projected 50 million lbs/year of incremental production, there is no more production growth included in the Americas’ Pipeline of 1.7 billion/lbs. However, they have identified a sizeable mineralized district with opportunities to expand production significantly, with pre-feasibility studies expected to be completed in late 2025.

Resolution of the conflict related to export duties in Indonesia: Recently, the government introduced a new regulation contradicting previously favorable dispositions outlined in the IUPK contract. While Freeport has fulfilled its obligations by completing the smelter project, the Indonesian government has imposed a 7.5% export duty on PT-FI (Freeport’s subsidiary). This duty amounted to $324 million in 2023. However, once the PT Smelter ramps up its operations, this duty is expected to be eliminated as all copper concentrate will be processed domestically. Additionally, Freeport’s export license extension beyond May 2024 is still pending.

FCX didn’t provide any new information about it in the earnings presentation. In the call, the historical and outgoing CEO, Richard C. Adkerson, said that they have had a good relationship with the Indonesian government for decades and remain confident in renewing the export license in May and the mining rights extension beyond 2041, as the government knows it would be very beneficial for the country and that there is no controversy with that.

However, they didn’t say anything about the current export duty, which disagrees with what was agreed upon in the IUPK contract. Oddly, the analysts on the call didn’t mention anything specifically.

First quarter operations

Copper production remained almost flat QoQ, with 1,085 million recoverable lbs (100% basis), compared with 1,095 in the previous quarter and up 13% YoY from 965. The increase is due exclusively to Indonesian operations, with higher mining and milling rates and good ore grades.

To provide more detail, the production growth was 120 million lbs YoY; the Grasberg district produced 162 million lbs of increased production. Almost all the remaining mines produced less, especially the biggest ones: Morenci, -14 million lbs YoY, and Cerro Verde, -18 million lbs YoY.

Leaching operations:

• In North America, we get an almost flat stacking rate YoY of 617.4 thousand tonnes per day (613.2 Q1 2023), but a decrease from 740.5 the previous quarter. Recoverable copper lbs was 211 million lbs compared to 223 the previous quarter and 234 a year ago.

• The situation was worse in South America, with a lower stacking rate of 170.4 thousand tonnes per day (193.5 in Q4 2024 and 203.9 in Q1 2023). Recoverable copper lbs was 71 million lbs, compared with 80 in the previous quarter and 86 a year ago. A slight improvement in the ore grade offset the decrease in production.

Milling operations:

• In North America, it remained almost flat with 153 million lbs of recoverable copper, though with slightly less efficient performance: same production with a higher milling rate. The CEO, Kathleen, noted that production suffered from the lowest ore grade since 2010, partly offset by improvements in leaching technology, but we don’t see it still reflected in the numbers. She went as far in the call as to say that North American operations haven’t been efficient during the last two years. And now, with the workforce more experienced and equipment operating more efficiently, things should change.

• In South America, production was mainly flat, with a slight decrease in milling rates associated with mill maintenance and a slightly lower production. The CEO noted difficulties concerning the ore types addressed in South America.

• Indonesian operations were again the driving force of growth with an increase of 33% in its production, 219.5 thousand tonnes per day milled compared to 164.8 a year ago, and 491 million lbs of recoverable copper (on a 100% basis) compared with 329 a year ago.

The current run rate would be around 1.9-2 billion lbs for 2024, up from FCX’s guidance of 1.8 for the current year and 1.6 for 2025. Given that they gave bold estimates of commodity prices but didn’t update this estimate, we should expect that Indonesian production has reached its plateau level. The next three quarters will probably see stable to lower production, barring any weather-related event.

Margin Compression and Unit Net Cash Costs Estimates

We get $1.51/lb of unit net cash cost for this quarter, a good measure in line with other copper miners. This is lower than previously estimated in January and lower from Q1 2023 ($1.76/lb) due primarily to higher copper volumes in Indonesia and higher by-product credits. The company expects $1.57/lb of unit net cash cost for 2024, again based on an aggressive assumption that the gold price will stay at $2,300 for the remainder of the year. They provided a sensitivity for this number of $0.04/lb for each $100 change in the average price of gold. A gold retracement to $2,180 would elevate unit net cash costs to $1.62/lb. This number would be a bit on the higher end relative to its peers.

·In North America, unit net cash costs came in at $2.98/lb higher from Q1 2023 ($2.45/lb) due to higher mining costs and lower molybdenum by-product credits. The same is true of South American operations, which were $2.60/lb higher than $2.20/lb a year ago, driven by lower copper volumes and by-product credits. And the Indonesian operations delivered the much-needed relief to costs with a net credit of $-0.12/lb.

Margins

FCX suffered this quarter from margin compression, from gross margins between 33-34% in the last quarter and one year ago to 30% this quarter. Operating margins also decreased from 29-30% to 26% this quarter.

The culprit is the increased site production and delivery costs (p&d), up 484 million (+14.4 % QoQ), which is a considerable amount, as it is the miner’s main expense category. If we look at the biggest assets, the cost pressures are generalized: Morenci’s P&D costs represented 61% of revenues in Q1 2023, compared with 79.6% in this quarter. Cerro Verde´s from 51.6% to 65% and Grasberg’s from 24.7% to 30.5%.

Management is seeing inflation in input costs moderating and prices stabilizing, and adding incremental pounds to stockpiles will drive down unit costs. The strengthening of the USD also benefits Indonesian operations concerning domestic expenses.

The situation looks less dire on a per-pound basis, with an 11% increase in North American production and delivery costs, a 2.8% increase in South America, and a remarkable decrease of -24% in Indonesia. But as I said, concerning management’s guidance, they are looking for a sharp improvement in the second half of the year. It seems stretched, and I expect downward revisions in the following quarters.

Ending Thoughts

Management didn’t comment much on their view about the copper run-up, nor did the analysts in the call ask them about it. The CEO remarked that copper fundamentals warrant an extended period of deficits and that physical conditions for concentrates remained tight.

For the short-term future, there is not much growth besides a continuation of the copper rally, about which I expressed my concerns. I don’t know what the market is expecting, but I know that the market is impatient. The market will not wait three to five years to see the expansion of the Bagdad mine, just mild improvements in its leaching initiatives to offset complex ore types in the Americas, and in the meantime, watching each quarter for no broad growth in its operations.

I continue to think that there is much to like about Freeport for the next decade:

• It is present in Arizona’s very safe mining jurisdiction, representing 48% of total copper production and 43% of its mineral reserves.
• It has a pretty good relationship with local communities in a complex country like Peru and has the option to boost operations in Chile.
• Through its PT-FI ownership, it possesses a much-envied collection of assets in Indonesia with low-cost operations.
• It has a proper debt leverage to make external acquisitions or develop organic opportunities.

However, production growth for the next two to three years will probably remain subdued, with the positives (leaching initiatives) offsetting the negatives (low ore grades and low recovery rates in the Americas). Earnings growth will be highly dependent on copper price developments.

Company guidance seems overly optimistic. Even its estimate for 2025 EBITDA seems stretched at $11 billion, when in 2021, with an average realized copper price of $4.33/lb, they obtained $10.2 billion, including non-controlling interest ($9.2 billion for common shareholders).

Therefore, being reasonable to think that FCX could probably continue to trade in a range, the $47-$50 spread is a good target to sell some of the position, up to 25%, take some profits, and wait for the price to cool down to a more fundamentally based price of $40-$42 to reload.