Today, Pat McKeough examines one of the world’s largest mining stocks in response to a question from a member of his Inner Circle. Freeport-McMoRan, which has mines on four continents, gets more than half of its revenue from copper, although in the past two years it has diversified into oil and natural gas with the acquisition of properties in three U.S. states. With commodity prices down, the company has engaged in aggressive cost-cutting. It also announced recently that it is prepared to sell a minority stake in its oil and gas business. These measures come in the wake of activist investor Carl Icahn taking an 8.5% stake in the company six weeks ago, a development which is expected to prompt further cuts and asset sales. Even in the face of weaker commodity prices, Freeport-McMoRan’s dividend appears secure.
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Q: Hello, Pat: May I please have your opinion on Freeport-McMoRan? Thank you so much.
 
A: Freeport-McMoRan Inc. (symbol FCX on New York; www.fcx.com) is a leading producer of copper, gold and other metals from mines in the U.S., Indonesia, Africa and South America.

In 2013, the company diversified into oil and natural gas by acquiring McMoRan Exploration and Plains Exploration & Production, which have properties in Louisiana, Wyoming and California, as well as wells in the Gulf of Mexico. Freeport paid a total of $9 billion for both companies.

In 2014, copper supplied 60% of Freeport’s revenue, followed by oil and gas, 20%; gold, 7%; molybdenum (which strengthens and prevents rust in alloys and high-temperature steels), 6%; and other minerals, 7%.

The U.S. accounted for 48% of total revenue, followed by Indonesia (8%), Japan (7%), Spain (6%), China (5%), Switzerland (4%), Chile (3%), Turkey (2%) and South Korea (2%). Other countries supplied the remaining 15%.

In the three months ended June 30, 2015, Freeport lost $1.85 billion, or $1.78 a share, after the plunge in oil and gas prices forced it to write down its oil and gas holdings by $2.7 billion. Without unusual items, the company earned $143 million, or $0.14 a share, down 70.3% from $482 million, or $0.46, a year earlier.

Revenue fell 23.1%, to $4.2 billion from $5.5 billion. Copper prices declined 14.2%, to $2.71 a pound from $3.16, offsetting a 4.9% production increase. Lower prices for gold, molybdenum and oil also hurt the company’s revenue.

Freeport is aggressively cutting costs in response to weak commodity prices: in the latest quarter, its cost per pound of copper produced fell 7.0%, to $1.85 from $1.99.

Mining stocks: Pressure from activist investor could lead to sale of high-cost U.S. mines

Freeport-McMoRan is also spending less on new mines and other upgrades. It plans to devote $6.3 billion to these projects in 2015, but that should fall to $4.0 billion in 2016. That’s partly because it’s close to completing expansions at mines in the U.S. and Africa.

These cuts will help free up cash Freeport can use to pay down its long-term debt of $20.1 billion, which is a high 1.8 times its currently depressed market cap. It also holds cash of $466 million.

To bolster its balance sheet, the company recently announced plans to sell up to $1 billion worth of new common shares at market prices. It also hopes to sell a minority stake in its oil and gas operations in an initial public offering.

The new firm, called Freeport-McMoRan Oil & Gas Inc., would trade on New York under the FMOG symbol. However, weak oil and gas prices have prompted Freeport to postpone the sale.

The stock moved up in late August 2015 on news that activist investor Carl Icahn now owns 8.5% of the company. He will likely pressure management to sell its high-cost mines in the U.S. and keep cutting operating costs and executive salaries.

Freeport continues to pay quarterly dividends of $0.05 a share, for a 1.8% annualized yield. It also paid a special dividend of $0.1105 a share in August 2015. This payment was part of a deal to settle a shareholder lawsuit that accused the company’s directors and executives of overpaying for its oil and gas acquisitions in 2013.

Weak commodity prices will probably cut Freeport’s earnings by 80.0%, to $0.40 a share in 2015 from $2.00 in 2014, though its profits are forecast to rebound to $1.86 a share in 2016. The stock trades at a low 6.0 times the 2016 estimate, but that prediction could prove optimistic if commodity prices weaken further.

Inner Circle recommendation: HOLD.