Weak Copper Prices And Problems In Indonesia Will Impact Freeport's Revenues
Freeport McMoRan Copper ( FCX ), the world's largest copper miner, is set to release its Q4 earnings on January 22. The majority of the company's revenues are derived from copper sales, which is extremely sensitive to cyclical industries such as construction and industrial machinery manufacturing. These industries in turn are heavily influenced by the macroeconomic sentiment and outlook. Macroeconomic factors in the fourth quarter were weaker year-over-year, especially as far as China is concerned. Therefore, copper prices on the London Metal Exchange in the fourth quarter were much lower year-over-year. Freeport is likely to report lower year-over-year copper revenues due to much lower prices in Q4 2013 as compared to Q4 2012.
However, production of copper in Q4 is expected to be higher year-over-year as production from Grasberg in Indonesia will be higher due to better ore grades. Also, reported revenues will be much higher year-over-year as the company has an oil and gas division this year which wasn't there in 2012.
Effect Of Macroeconomic Factors On Copper Prices
Copper is often called "Dr. Copper" for being a bellwether of the world economy due to its close correlation with economic growth. It is used by many industries and prices typically rise when the world economy is growing. Hence, macroeconomic factors are important for copper and Freeport.
Going by the copper price data on the London Metal Exchange (LME), the average realized price of copper for Freeport is likely to be lower this quarter on a year-over-year basis.
The lower prices in the fourth quarter this year are in line with the Chinese GDP growth rate of 7.7% for the quarter. The Q4 2012 GDP growth rate was 7.9%.
Effect Of The New Rules In Indonesia
Fears were being expressed that Indonesia's proposed ore export ban effective January 12 would cripple Freeport McMoran's copper operations in the country. It was expected that its copper production would come down by 60% since it processes only 40% of its produce before exporting it. Potential revenue losses to the company were pegged at $5 billion or more. However, a last-minute intervention by the Indonesian government saved the company temporarily from the ban. It has been granted time till 2017 to arrange for its copper to be processed within Indonesia before exporting it. (( Here Are the Winners of Indonesia's Ore Ban , Daily Finance))
However, while granting Freeport an exemption from the ban, the government simultaneously slapped a new export tax of 25% on the copper concentrate it will export. While the export tax already existed and was previously charged at 20%, Freeport had been exempt from it owing to the terms and conditions laid out in its contract which does not provide for payment of an export tax. The government has now effectively violated the contract by slapping a new hefty tax on Freeport. Indeed, the company said that legal arbitration is a possibility if the tax is not rolled back.
Meanwhile, Freeport's copper shipments from Indonesia have been on hold since December 15 in absence of clarity over the new rules. This means that the company won't be able to record revenues it could potentially have generated in the latter half of December, and the impact will be visible in its fourth quarter results. Going forward, if the government doesn't roll back the proposed tax, first quarter results for 2014 are certain to be affected.
What We Will Be Watching In The Earnings Call
In the earnings conference call, we would like to hear Freeport management's view on copper prices in 2014. The Chinese economy is in a phase of transformation and moving towards a consumption-led growth model from an investment-led growth one. The economy is expected to cool further in 2014 which will have adverse implications for industrial metals like copper of which China consumes 40% of the total world production. Indeed, the Chinese GDP data for the fourth quarter immediately caused the price of copper to fall.
We would also like to have a glimpse of Freeport's strategy to deal with the situation in Indonesia. Specifically, we would like to know whether the company will continue to keep exports on hold even if it decides to go for arbitration and the process takes time. Freeport's decision in this respect will have a material impact on its revenues and cash flows for the first quarter of 2014 and possibly beyond it.
We have a Trefis price estimate for Freeport McMoran Copper of $29 , which represents 18% downside to the market price.
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