Freeport McMoRan Copper (NYSE:FCX), the world’s largest copper miner, is set to release its Q3 earnings on Monday, October 22. Global macroeconomic conditions remain largely unchanged from the previous quarter. The European debt crisis is far from resolved, employment growth is yet to convincingly return to the U.S., and Chinese economic growth continues to decelerate.
Compared with the same period of last year, we expect lower realized prices of copper to weigh on the earnings even as relatively higher prices of gold could lend support to some extent. However, higher input costs and expenses could negatively impact margins. The company has reported decreasing revenue in the previous three quarters. The year-over-year drop in revenue was 23% in Q2 2012. Revenue fell by 19.3% in Q1 2012 and by 25.7% in Q4 2011. ((Forbes Earnings Preview: Freeport-McMoRan Copper & Gold, Forbes))
Freeport is a global miner with mines in the U.S., South America, Indonesia and Africa, and has a product portfolio spanning basic metals like copper, gold and molybdenum. Its primary asset in Indonesia is the Grasberg mine, which is the largest gold mine and the third largest copper mine in the world. The company has been facing demands for increasing royalties paid to the government. The government is also seeking to impose an obligation on mining companies to carry out ore processing operations in Indonesia itself.
In the first half of the year, the company had produced 1.7 billion pounds of copper, 503 million ounces of gold, and 41 million pounds of molybdenum. In 2012, the company expects to sell 3.6 billion pounds of copper, 1.1 million ounces of gold and 81 million pounds of molybdenum, including 885 million pounds of copper,225 thousand ounces of gold and 20 million pounds of molybdenum for Q3 2012. 
Freeport’s Grasberg project has been dogged by controversies for years over various contentious issues such as royalties, workers’ pay, and pollution. This has often resulted in strikes by workers which has had direct bearing on Freeport’s production figures and profits. However, the potential of the Grasberg mine is so huge that Freeport has persisted against all odds. 
Indonesia has asked metal mining companies, including the local unit of Freeport McMoRan Copper’s (NYSE:FCX), to raise royalties to 10%. This demand has been made as a part of ongoing broad-based negotiations with the mining companies operating in Indonesia. These negotiations are focused on six main issues: increase in royalty payments, the obligation to process mineral ores in Indonesia, use of local goods and services, divestment, contract extensions, and the size of mining areas. PT Freeport Indonesia, Freeport’s Indonesian subsidiary, currently pays 1% as royalty for mining gold and 3.5% for copper.
Any increase in royalties will have an impact on the future results of the company, but not on those of Q3 2012. Unless, of course, the Indonesian government decides to impose the increased royalty with retrospective effect.
Projects On Track
The company is currently working to ramp up production at the Climax molybdenum mine and expects to produce roughly 20 million pounds of Molybdenum in 2013. The eventual aim is to increase capacity to 30 million pounds a year. The Tenke copper project in Africa remains on track and is expected to be completed in 2013. The Cerro Verde project in South America, worth $4 billion, to expand the concentrator facilities is progressing well. The management wants to expand the concentrator’s capacity from 120,000 metric tons to 360,000 metric tons of ore per day.  By 2014, the company expects to sell more than 5 billion pounds of copper per year, 1.7 million ounces of gold and 90 million pounds of molybdenum. You can examine the impact of sales volumes projected for 2012 and 2014 on the company’s Trefis valuation :
Long Term Outlook Bright
The company may continue to face short-term headwinds as copper prices may remain under pressure due to slowing Chinese growth.
However, we are bullish on the company’s long-term outlook. We expect Freeport to maintain positive momentum as copper demand from China will likely remain strong in the long-term despite some near-term shocks from the country’s reduction of its target GDP growth rate. We believe importers will start re-stocking copper in the second half of the year, which will allow for strong copper prices, going forward.
Further, the Fed’s decision to keep interest rates at near-zero levels through the “Unlimited QE” program should help gold continue its run. Freeport’s investment in the expansion of its mining operations should also prove beneficial to the company in the long run.
We have a Trefis price estimate for Freeport McMoran Copper of $44 which is nearly 10% above its market price.Notes:
- Q2 2012 Earnings Conference Call, Freeport McMoran Copper Website [↩]
- Cave In: Freeport-McMoRan Digs A Heap Of Trouble In Indonesia, Forbes [↩]
- Indonesia Seeks to Increase Royalties From Mineral Mining to 10%, Bloomberg Businessweek [↩]
- Freeport-McMoRan: Is It Ready To Break Out?, Seeking Alpha [↩]