SQM - Freeport-McMoRan: The Pain May End Soon

2023-05-22 15:00:00 ET

Summary

• Freeport-McMoRan investors have endured a difficult first half of 2023 as FCX fell more than 25% from its January highs.
• China's nascent post-COVID recovery has fizzled out, worsened by higher copper supply, weakening buying sentiments further.
• Freeport also needs to navigate its current negotiation with the Indonesian government, adding another layer of execution risks to its mines in Indonesia.
• However, FCX is no longer overvalued, and its price action suggests bottoming out could happen soon.

Freeport-McMoRan Inc. ( FCX ) investors have likely been taken aback by the steep pullback in FCX since it topped out in January 2023. It fell more than 25% toward its recent May lows, trapping over-optimistic buyers who chased its momentum surge earlier this year.

However, it also allowed astute sellers to take profits and cut exposure, as FCX was not attractively valued at those prices. Recent economic data from China has justified the battering in FCX, as industrial and consumer spending data remain weak and tepid, worsened by poor employment indicators.

In addition, the property market recovery has also slowed down, adding another layer of uncertainty to the market. In addition, the International Energy Agency or IEA " lowered its assessment of how much oil China will actually use" this year, adding more pessimism over China's post-COVID economic recovery.

I highlighted in my previous article urging investors not to be "blindsided by optimism" in Freeport's performance as FCX's valuation was no longer attractive.

Recent industry data suggests that the copper inventory stockpile has been building up, worrying investors further. However, industry players expressed their confidence that China's economy is " resilient " and " expect demand to continue expanding in China." However, Bloomberg also underscored that "p rivately, Chinese traders and market players expressed a downbeat mood." They pointed to "poor economic data and the lack of substantial stimulus measures from Beijing."

Freeport CEO Richard Adkerson also highlighted these near-term challenges in a recent conference. He articulated:

You all know more about what to expect in the near-term economy from all the complications we have, inflation and China and the situation in Europe, central bank policies, and all of that. So that creates a lot of uncertainty near term. - BofA Securities Global Metals, Mining & Steel Conference

Despite that, Adkerson remains confident about the long-term prospects of the copper industry. He also reminded investors that Freeport's investment focus will remain primarily on copper, despite its assets in gold and molybdenum.

Furthermore, Adkerson believes his confidence has a reasonable basis as the world increasingly shifts toward a renewable future. He stressed constructive developments in artificial intelligence and electrification, suggesting that more long-term copper investments are needed to realize the potential of these developments.

However, bringing more copper mines up to speed takes significant time, as Adkerson reminded investors that the leading copper players "cannot quickly ramp up production, as significant time is required for engineering, permitting, and structuring new projects."

For instance, PT Freeport Indonesia or PT-FI (majority owned by the Indonesian government) is still in the pre-production phase for its Kucing Liar deposit, which is "expected to produce over 6 billion pounds of copper and 6 million ounces of gold between 2028 and 2041."

The company expects the pre-production phase to take "approximately 10 years" from 2022. Therefore, I assessed that positive medium- and long-term demand/supply dynamics should undergird Freeport's optimism, despite the near-term volatility.

However, some investors could have been spooked by the current negotiations between FCX and the Indonesian government to extend its permit beyond 2041.

The Indonesian government has reportedly asked to increase its stake in PT-FI from 51% to 61% as part of the negotiation process at the " most cost-effective pricing."

Adkerson responded to a question at the recent conference regarding the negotiation process. He assured investors that "the negotiations are not urgent" like previously. He also stressed that the relationship with the Indonesian government is "positive," as he remains hopeful of an outcome that's beneficial for FCX and Indonesia.

Therefore, some FCX bears could point out the political headwinds of having significant investments in a foreign country, similar to what happened recently with leading Chilean lithium miner Sociedad Quimica y Minera de Chile S.A. ( SQM ). The Chilean government has decided to nationalize the country's lithium mining industry, putting the company's future beyond 2030 at risk as its permits expire.

Therefore, FCX investors must continue monitoring the developments of the company's negotiations with the Indonesian government, although I don't expect a significant near-term impact.

Given the steep pullback from its January highs, FCX's valuation has improved and is slightly undervalued now.

I see a distinct possibility of FCX's price action bottoming out at the current levels if buyers could return strongly.

While I would prefer a steeper pullback, my analysis of the underlying copper futures suggests a possible near-term bottoming, which should bolster the buying sentiments in FCX.

As such, I'm ready to revise my rating, given the current pessimism and more attractive valuations leading to an improved risk/reward at the current levels.

Rating: Buy (Revised from Hold).

Important note: Investors are reminded to do their own due diligence and not rely on the information provided as financial advice. The rating is also not intended to time a specific entry/exit at the point of writing, unless otherwise specified.

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