The whole point of buying a miner, such as Freeport-McMoRan Inc (NYSE:FCX), is to gain leverage to underlying commodity prices. Imagine (in an overly simplistic hypothetical) a mine owned by FCX that mines copper at a cost of $2 per pound. An investor bullish on copper can buy a futures contract at $2.20 a pound — or buy FCX stock. If copper rises 10% to $2.42, the futures contract should rise 10%. In contrast, the earnings attributable to FCX stock increase 110% as profits increase from 20 cents per pound to 42 cents per pound.
Again, this is simplistic, but the broader point holds: Mining shares such as FCX stock should outperform when the underlying metal rises. The risk, of course, is that copper falls — in the same scenario, a 10% decline in the price of copper wipes out Freeport profits.
The problem for Freeport-McMoRan, and the mining sector as a whole, is that miners have done an awful job of driving that leverage and creating shareholder returns. FCX stock has offered basically zero appreciation for over two decades now. Only a now-paused dividend provided any return, which still totals less than 1 percent a year.
The responsibility for those low returns is on FCX, not its markets. The company entered the oil & gas business in 2013, just ahead of the U.S. shale oil bust. Execution has been spotty at best, and labor issues have beset the company.
Recent performance is a microcosm of those problems. Copper is near a 20-month high, but FCX stock is dropping. And the recent problems provide further evidence that FCX, in particular, is not the way to play higher copper.
Too Many Errors To Buy FCX Stock
Freeport-McMoRan still is dealing with the impacts of its past decisions, most notably on its balance sheet.
FCX has made debt reduction its priority but it’s come at a price. The company’s dividend has been paused. Freeport sold $6.6 billion in assets in 2016, most notably its share in the Tenke joint venture in the Democratic Republic of Congo. And it issued $1.5 billion in stock in November.
All of those decisions penalizes the FCX stock price. The cut dividend takes away the company’s attractiveness as an income investment, and limits ETF buying. The asset sales obviously impact Freeport-McMoRan’s future earnings potential. In part, due to those sales, FCX is guiding for lower sales of copper, gold, and molybdenum in both 2017 and 2018. Cash flow and EBITDA figures should increase but only if pricing holds.
And while some FCX stock bulls point to commodity prices as a problem, that’s not the whole story. Lower copper and gold prices are coming in part due to the strength of the U.S. dollar. Gold priced in euros, for instance, actually has been in an uptrend for more than three years now. Euro-priced gold is up by roughly 33% since late 2013.
That strong dollar, however, benefits FCX costs, bringing down spending in local currencies. A 10% strengthening of the dollar in 2017, per Freeport-McMoRan guidance, would add $145 million to Adjusted EBITDA on its own. The cumulative effect of dollar strength the last few years has been in the hundreds of millions of dollars a year.
And yet, again, FCX hasn’t taken advantage. FCX stock is down 60% over the same period.
Always Something For FCX Stock
Meanwhile, FCX now is dealing with problems in Indonesia, where the country halted concentrate exports in January. Indonesia is looking to amend the terms of its contract with FCX. In response, Freeport-McMoRan has claimed a violation of its original 1991 contract.
FCX now has declared force majeure, and refused the conditions of a potential export permit offered earlier this month. The key Gramberg mine — which drives about one-third of Freeport-McMoRan copper sales — now is reducing production and shedding workers.
To be fair, it does seem like Freeport-McMoRan has a solid case, and some of Indonesia’s new conditions do appear to violate the 1991 contract. But that’s kind of the point relative to FCX stock and miners more broadly: there’s always something. Political risk is part and parcel in the space, as most major mines are located in emerging markets. Labor pressure, as seen in a recent strike at peer BHP Billiton Limited (ADR) (NYSE:BHP), tends to pop up in good times.
This is an industry that has destroyed shareholder value. And Freeport-McMoRan has been no exception. That raises the question: why bother? If an investor wants to bet on rising copper prices, why take on the debt reduction issues, and the dilution potential, and the execution risk, of FCX stock? Why run the risk that higher prices may come in part from lower production from the Gramberg mine in Indonesia?
Investors can invest in copper directly through futures or ETFs. Leverage is available through options on those underlying issues. That’s a clean bet on the metal’s price and one that will pay off if copper rises. The same can’t be said for FCX stock. That’s been proven for years… and it’s being proven again at the moment.
As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.