|  | | March 15, 2024Inflation Protection Stock Pick |
| | Freeport-McMoRan (FCX): Electrified returns |
| In the last issue, we talked about how AI champion NVIDIA (NVDA) was taking over the stock market and the world. We also talked about Digital Realty Trust (DLR), the data center REIT that we own in the Income Builder portfolio, which will benefit from the explosion in accelerated computing that companies like NVDA are driving.
In this issue, we bring you another interesting play on the high tech future that awaits us all (whether we like it or not). Is it another semiconductor play? No. Cloud-based software company? No.
It’s Freeport-McMoRan (FCX)—a Phoenix, Arizona-based mining company whose history dates back to 1834, when its corporate predecessor, Phelps, Dodge Company, started producing copper and brass kettles.
FCX is now one of the world’s leading copper mining companies and is a recommended investment within our Inflation Protection Model Portfolio, which we just initiated along with our other Model Portfolios on March 1.
Copper prices have advanced in response to recent reports of Chinese smelters cutting production, which is expected to lead to tighter supplies. This news helped drive shares of FCX up approximately 15% month-to-date.
We chose to feature FCX in this issue because copper supply shortages like this are precisely what we think will make FCX a very strong long-term performer.
While the stock is primarily a copper play, FCX derives about 15% of total company revenue from gold production. So in addition to being a play on our high tech future, it’s also a little bit of a play on gold.
“Wait, you haven’t explained why a copper miner is a tech stock.” Hang on, we’ll get there! First, a brief history of the critical role of copper in the development of human civilization, because it’s too fascinating to skip! |
| | Archaeological evidence demonstrates that copper was one of the first metals used by humans and was used at least 10,000 years ago for items such as coins and ornaments in Western Asia. During the prehistoric Chalcolithic Period (derived from chalkos, the Greek word for copper), man discovered how to extract and use copper to produce ornaments and implements… The discovery that copper, when alloyed with tin, produces bronze, led to the Bronze Age, c. 2,500 BC…. The Greeks of Aristotle's era were familiar with brass as a valued copper alloy. In South America, the pre-Columbian Maya, Aztec and Inca civilizations exploited copper, in addition to gold and silver. During the Middle Ages, copper and bronze works flourished in China, India and Japan. The discoveries and inventions relating to electricity and magnetism of the late 18th and early 19th centuries by scientists such as Ampere, Faraday and Ohm, and the products manufactured from copper, helped launch the Industrial Revolution and propel copper into a new era. - International Copper Study Group (ICSG) |
| | So how is copper a tech play?
The world is turning into Star Wars, or Star Trek, or whatever futuristic sci-fi metaphor you prefer.
Copper is a play on electrification. Electrification is the technological trend of increasing electronic content within everyday items. There are many factors driving this. Decarbonization is one of them, and a lot of emphasis gets placed on it.
Regardless of one’s views on renewable energy policy (and the extent to which the private sector should be pressured into transitioning towards renewables), the sector is benefiting from enormous investment. The move away from fossil fuels towards wind, solar, batteries and grid-based energy distribution is a key driver of the electrification trend.
Electrification is not just about carbon emissions, though. Consider electric vehicles. Teslas may or may not be better for the environment on balance (when you actually take into account the full scope of environmental impacts). But Elon Musk has produced an incredible car, and for a variety of reasons, they are incredibly popular with consumers.
As all the products we own become “smart,” as the overall amount of computing that takes place in the world grows steadily (especially now with AI), the tools and resources needed to create all this electronic content will be in high demand.
The raw material of the future
From a high tech angle, semiconductors are among the best ways to play the electrification theme, but from a commodity perspective, it’s copper. The semiconductor industry relies on copper for its conductive properties, but copper is also used for more basic purposes like electrical wire that high tech would be useless without. Copper is unmatched among non-precious metals for its conductive properties as well as its durability, ductility and corrosion-resistance.
According to the International Copper Study Group (ICSG), approximately four times as much copper is used in an electric vehicle versus an internal combustion vehicle. The more things become electronic in nature, the more copper is required.
Copper is also used across a wide range of construction and industrial applications. To be fair, growing demand for copper is nothing new. It’s just that it’s poised to grow even faster as new technologies proliferate. As the entire world, especially the developing world, has become wealthier and has more access to high tech goods, per capita copper consumption has only grown. |
|  |  | While long-term demand for copper should continue to move up and to the right, over the past few years, Chinese construction-related demand has faltered. Cyclical problems afflicting the Chinese real estate market have constrained growth in copper prices, although now around $9,000 per ton, they are close to their highest levels in a year. Copper prices are, however, still off their all-time highs when they were just over $10,000 per ton in 2021-2022. |
|  | | Meanwhile, the supply-side of the equation is more in doubt. Like all commodity markets, cyclical weakness on the demand side leads to reduced investment in capacity. The faltering Chinese real estate market means there has been diminished appetite for mining companies to make the multi-billion dollar commitments that are required to expand capacity.
A key point here is the extremely long lead times required to get a large scale copper mine going—very typically, around 15 years. If demand exceeds supply, the industry cannot quickly respond with more supply, the way other industries can. |
| | Longer lead times for copper mines reflect greater complexity and greater infrastructure investment to transport the ore to export markets. - The World Bank, Vulnerabilities and Policies in LICs |
| | The supply challenge with copper goes beyond the industry’s short-term concerns on China, however. Copper as a metal shares many of the same physical properties as gold and is found in a limited number of overlapping geological locations (and often mined simultaneously with gold). There is much more copper in the world than gold, but it’s not everywhere, and it’s not easy to extract. |
|  | Copper production faces many long-term challenges, including declining ore grades on existing mines. ESG has only made matters worse.
In general, ESG has made the practice of mining (which involves a significant number of environmental impacts including fossil fuel consumption, in particular coal) more costly and less appealing.
This calls to attention yet another paradox of the ESG movement. Decarbonization requires electrification, which requires more copper production. Yet ESG is raising the cost of capital for copper producers and discouraging investment in all the industrial layers of copper mining, from coal to diesel-powered construction equipment.
ESG defunds the mining industry
The end result is that ESG is making copper less abundant and therefore more expensive. In this way, ESG is actually undermining its own “zero carbon” ambitions, while also driving up inflation and slowing down technological progress.
To sum up, we favor exposure to copper assets because the world is on a trajectory, which will only be accelerated by growth in AI, to consume much more copper. But, for various reasons, ranging from the China real estate crash to the ESG clampdown on mining investments, the world has not been investing as much as it should have been to meet this long-term demand.
The implication is higher prices down the road and significantly higher profits for owners of copper mining assets. For this reason, we think it makes sense to own stocks that own copper mines. |
| | The supply side is so strongly supported and the world is going to get more electric. It's not going to be as smooth and easy thing, but we've got a great set of assets to build on internally, and we got a great team. - Richard C. Adkerson, Chairman & CEO, Freeport-McMoRan, BMO Capital Markets Conference, 2/23/2024 |
| | FCX’s Operations
FCX is among the largest copper mining companies in the world. With a market cap that currently exceeds $60 billion, FCX also generates a smaller but material portion of its revenue from mining molybdenum (a metal used in high-strength steel alloys) and gold. |
| Molybdenum (element #42, symbol Mo) is a metallic, lead-gray element, with a high melting point (4,730 degrees Fahrenheit). This is 2,000 degrees higher than the melting point of steel…. It is alloyed with steel making it stronger and more highly resistant to heat. The iron and steel industries account for more than 75% of molybdenum consumption. - Minerals Education Coalition |
|  | | FCX operates in three key geographies: the United States, South America and Indonesia.
United States FCX has nine copper and molybdenum operations across Arizona, New Mexico and Colorado. The largest of these is the Morenci open-pit copper mining complex in Greenlee County, Arizona, which has been operating continuously since 1939. Morenci is 72% owned by FCX, with the remaining interests owned by entities affiliated with Japan’s Sumitomo Corporation. The other U.S. mining assets are wholly owned by FCX.
South America The company has two mining operations in South America. In Peru, Cerro Verde is an open-pit copper and molybdenum mining complex. FCX has a 54% interest in the operation with Sumitomo and other investors owning the remainder. In Chile, FCX owns a 51% interest in the El Abra open-pit copper mining complex. Codelco, the state-owned Chilean mining company, owns the remaining 49%.
Indonesia PT Freeport-Indonesia (PT-FI), a joint venture between FCX (49%) and the Indonesian government (51%), owns mining operations in the Grasberg minerals district, which is located in the remote highlands of the Sudirman Mountain Range in the province of Papua, Indonesia, on the western half of the island of New Guinea. PT-FI has the world’s largest underground copper mining operation and the world’s second largest copper mine, producing 1.7 billion pounds of copper in 2023. PT-FI also produced 2 million ounces of gold in 2023, which makes it one of the largest gold mines in the world. |
|  | Panoramic view of Grasberg mine |
| Why FCX in particular?
There are a number of different ways to play the copper story. We like FCX in particular because it offers a blend of attractive attributes.
Asset quality As noted, from a geological perspective, copper, like gold, is not found everywhere. In fact, it is often found in difficult jurisdictions. The value of FCX’s mining assets is roughly equal across the three main geographies. The U.S.-based assets naturally pose the least political risk, while we have confidence in its joint venture partnerships with state-owned operators in South America and Indonesia. FCX is a premier operator, and these countries rely on that expertise to generate the revenue they seek from their natural resources. The Morenci mine in Arizona and the Cerro Verde mine in Peru are widely viewed as two of the best copper mines in the world because of their production levels, low production costs and long-lived reserves. |
| | What's been really great about our relationship with the Indonesian government over the last five years since we signed the new agreement in 2018 is that now the government is a partner with us in the operation. And so, there is a lot greater and deeper understanding of the need – the long lead times involved in mining…. So that's been a real benefit of bringing together the Indonesian government as an owner in this asset, is a much stronger alignment than there ever has been in the operation. - Kathleen Quirk, President, Freeport-McMoRan |
| | Management FCX’s CEO of 20 years, Richard Adkerson, is retiring this year but is being replaced by a 35-year veteran of the company with a financial/accounting background, Kathleen Quirk. Ms. Quirk is well-known to the investment community and well-regarded as a careful manager and culture carrier. Along with financial discipline, the mining business requires excellent management of government counterparties and other constituents. We are confident in FCX as operators, given their successful long-term track record.
Capital allocation FCX demonstrates capital discipline, with a conservative balance sheet (net debt/EBITDA below one turn) and a commitment to return 50% of free cash flow annually to shareholders. Since 2021, FCX has returned nearly $4 billion to shareholders (about half of which through share repurchases, one-quarter through a base dividend and one-quarter through a variable dividend). FCX has a high quality pipeline of cap ex opportunities to improve cash flows and production within its existing network of mines.
Gold exposure As noted, FCX stands out among copper producers for its gold exposure. According to the company, every $50 move in the gold price can be expected have almost a 1% impact on cash flow.
Valuation Consensus forecasts call for meaningful growth across all relevant financial metrics over the next several years, based on organic growth and modest improvements in commodity prices. A more significant movement in copper and other metal prices will likely allow FCX to exceed expectations significantly.
Conclusion
With excellent assets, strong management and unusually high gold exposure, FCX is a solid choice for investors looking to play long-term demand for copper as a key resource underpinning the ongoing electrification of society. It is also an excellent way to profit from counterproductive ESG policies, which have raised the cost of capacity expansion and contributed to significant global underinvestment in copper mines.
Source: All facts, figures and financial forecasts above are based on Freeport-McMoRan company disclosures or FactSet data, unless otherwise cited. |
| | Freeport-McMoRan (FCX): Company Snapshot |
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