Freeport-McMoRan (NYSE: FCX) is the largest publicly traded copper producer in the world. Because of that, the company unsurprisingly makes most of its money on copper.
The company’s outsized exposure to one commodity is important to note since it drives whether the stock is worth buying or not. That’s because Freeport-McMoRan’s earnings, and therefore its stock price, will likely move alongside copper’s price. This factor is why it’s crucial for investors to look at where the price of copper might go in the future since that would be the major factor determining whether they should buy Freeport-McMoRan’s stock.
Highly sensitive to copper
Freeport-McMoRan expects to produce about 3.8 billion pounds of copper this year, along with some gold and molybdenum. At copper’s recent price of $3.15 a pound, Freeport estimates that it will haul in $5.6 billion of operating cash flow this year. With just $2 billion of capital projects underway, the company is on pace to generate a huge windfall of excess cash if copper remains at its current level.
However, given Freeport’s outsized exposure to copper, any change in its price can have a significant impact on cash flow. In fact, the company noted that if copper averages $0.10 per pound more or less than $3.15 for the balance of the year, it would impact cash flow by roughly $250 million. Because of that sensitivity to the price of copper, shares of the copper giant could move sharply if the commodity makes a big move in either direction. This is why investors need to be very bullish on the copper market before they consider buying Freeport’s stock.
The bull case for copper
Several analysts see good reasons to be bullish on copper. “The bull market has only started,” according to Leigh Goehring, a managing partner at Goehring & Rozencwajg Associates. Goehring further said that “strong demand from Asian countries is what’s going to push copper prices higher, and this is before we even begin to talk about renewables and [their] impact on global copper consumption,” since wind, solar, and electric vehicles require significant amounts of copper. That’s why he believes there will be a “huge bull market” in copper that will play out in “multiple stages over the next five to 10 years.” In Goehring’s view, copper could top $10 a pound at its peak. At that price point, Freeport-MacMoRan would rake in a huge windfall of cash flow, which would enrich investors.
Goehring isn’t the only one bullish on the price of copper. Analysts at Wood Mackenzie estimate that the copper industry needs to bring 4.5 million metric tons per year of new copper production on line to meet growing global demand over the next decade. However, given the long lead time needed to bring new mines or expansions on line, it appears inevitable that rising copper demand driven by global economic growth and renewables will eventually outpace supply, which could cause prices to spike.
This bullish outlook bodes well for Freeport-McMoRan since it’s one of the few companies with the low-cost copper reserves to help meet growing demand. It already has several expansions underway, including the Lone Star Oxide Development Project. The company is investing $850 million into the project, which should come on line by the end of 2020 and produce about 200 million pounds of copper per year.
The bear case for copper
While copper’s long-term outlook appears bright, several potential issues could impact demand and therefore the price of copper in the near term. China is the world’s largest copper consumer, which is important to note given the brewing trade war with the U.S. If tensions continue escalating, “copper would certainly take a hit,” according to Jay Jacobs, the direction of research at Global X. Even copper bull Goehring noted that “global trade wars aren’t good for anybody, so if one breaks out, it will be a headwind for all commodity markets, including copper.” If that happens, copper’s price could fall back below $3 per pound in the near term, likely taking Freeport’s stock down with it.
That pricing level is also worth noting since Freeport needs higher copper prices to earn an acceptable return on its investments in expanding production. Lone Star, for example, has an after-tax net present value (NPV) of $1.2 billion if copper averages $3.50 a pound. However, that NPV drops all the way down to $0 if copper were to tumble to $2.40 a pound, which for perspective is higher than its average price for most of 2016. Because of that, if copper is one of the casualties of a global trade war, Freeport-McMoRan could have a big writedown on its hands, which would likely sink shares.
The right commodity at the right time
As the world’s largest publicly traded copper producer, Freeport-McMoRan lives and dies with the price of copper. While there is some cause for concern in the near term due to global trade war fears, the long-term outlook for the copper market looks bright. Conseqently, Freeport-McMoRan appears to be a compelling stock to buy as a way to profit from what seems to be the early innings of a long-term bull market in copper.
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