HT Ganzo
In July of this year, I concluded that it was time to become upbeat on Freeport-McMoRan (NYSE:FCX) despite a big pullback seen in copper prices at the time.
This decline in prices took shares of Freeport along with them, as they lost nearly half their value from a high just a couple of months before, driven by copper prices seeing a big pullback. This was somewhat surprising as inflationary pressures were seen across many commodities and the economy at large.
A Quick Recap
Shares of Freeport have seen excessive volatility in the long haul, driven in part by poor capital allocation decisions. Shares peaked around the $60 mark in 2011, yet a decline in copper prices, and poorly timed investments into the oil and energy sector, made that shares fell to the mid-single digits in 2016. Ever since, shares have only seen a modest recovery.
The 2021 results were relatively solid, as the company has seen a recovery coming out of the pandemic. After revenues came in at nearly $15 billion in 2020, on which net earnings of $599 million were reported, financial performance improved meaningfully in 2021. Revenues rose in a spectacular fashion to $22.8 billion on which operating earnings of $8.3 billion were reported.
Net earnings came in at $4.3 billion, equal to $2.90 per share. These strong results were driven by a high copper price, averaging $4.30 per pound, amidst rising production volumes and costs being well managed. Such earnings power furthermore resulted in net debt being down to $1.4 billion, as the company reinstated a divided, now running at $0.60 per share.
These results made that shares rallied to the $50 mark in March, on the back of the geopolitical tensions and high copper prices. This was driven by the 2021 earnings power and the fact that copper prices rose to $5 per pound, evident in the first quarter results as the company posted earnings of $1.04 per share on $6.6 billion in sales.
With spot pricing down to $3.30 per pound in July, the decline in oil prices would hurt quarterly revenues by around $1.3 billion in lower quarterly revenues and would likely have a huge impact on earnings as well. In fact, almost all earnings could be wiped out in such a case, and hence shares sold off some 50% during the second quarter.
On the other hand, net debt was close to entirely being wiped out, totaling $1.3 billion at the end of the first quarter. With copper underperforming many other commodities, and copper being important in the long term energy transition, shares looked quite interesting at $26, leaving me a happy buyer of the shares at the time.
A Big Rebound
Since July shares have risen meaningfully, now trading at $38 per share, which is essentially a 50% return in just about half a year, a huge return by all means as it seems that the share price action in the summer indeed was an overreaction. Copper prices came in at $3.30 per pound this summer and have recovered a bit in recent weeks, now trading at $3.75 per pound.
Second quarter revenues came in at $5.4 billion which was in line with my estimates on the back of a decline in copper prices. Net earnings fell to $840 million, for earnings of $0.57 per share, cut in half compared to the first quarter, yet better than I feared given the underlying copper price movements. This does not come completely unexpected of course as prices were still coming in a bit higher at the start of the quarter.
Third quarter sales fell further to $5.0 billion as the lower prices were seen during the entire quarter, with earnings down further to $404 million, equal to $0.28 per share. This means that on a sequential basis, earnings have been cut in half again for two consecutive quarters now.
Net debt inched up to $2.1 billion on the back of lower earnings, some higher capital investments, dividends and share buybacks. With earnings power trending around $1 per share based on the third quarter results, we should likely see modest earnings growth again in the fourth quarter as copper prices have recovered a bit. That being said, earnings power likely comes in somewhere around $1.50 per share, on an annual basis, leaving me cautious given the price moves seen in the share price.
Concluding Remark
Given the discussion above, that of a 50% share price recovery in just six months’ time (or even a bit less), while the worsening earnings numbers have become a reality, the risk-reward has become a lot less compelling here.
In fact, the risk-reward situation deteriorated so much in my view that I am taking the chips off the table here, keeping a close eye on the volatility to perhaps opportunistically initiate positions again in the future.
