Grasberg Shutdown And Weak Copper Prices Will Dull Freeport’s Earnings

by Trefis Team
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Freeport McMoran Copper
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Freeport McMoRan Copper (NYSE:FCX), the world’s largest copper miner, is set to release its Q2 earnings on Tuesday, July 23. The majority of the company’s revenues are derived from copper, which is extremely sensitive to cyclical industries like construction and industrial machinery manufacturing. These industries in turn are heavily influenced by the macroeconomic sentiment and outlook. Macroeconomic factors in the second quarter haven’t been very encouraging, particularly as far as China is concerned. This has led to much lower copper prices year-over-year as well as sequentially and will have a negative impact on Freeport’s revenues.

The other factor that will impact Freeport’s revenues is the production lost to a prolonged shutdown at the Grasberg mine in Indonesia. It is the company’s biggest mine in terms of the quantity of copper produced, despite the fact that production here has declined by almost half of its peak level two years back. Freeport now expects the mine to produce only 80% of its targeted output of copper, gold and silver for the year.

See our full analysis for Freeport McMoran here

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 to 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 sequential and year-over-year basis. Volumes sold are not likely to be higher than the previous quarter so we don’t expect much revenue growth. Prices were influenced largely by the prevailing macroeconomic scenario. [1]

Global macroeconomic conditions remained challenging this quarter. The economic growth rate in China, which accounts for nearly 50% of the world copper consumption, continued to be sluggish. The growth rate for the second quarter was reported at 7.5%, which is lower than the previous quarter’s growth rate of 7.7%. The pessimistic forecast is based on discouraging data in the manufacturing sector for May and June. Manufacturing constitutes nearly 40% of China’s Gross Domestic Product (GDP) and the HSBC Purchasing Managers’ Index (PMI) data for these two months suggests that manufacturing activity has contracted. [2]

Impact Of Grasberg Shutdown

On May 14, a tunnel collapse at the Grasberg mine resulted in the death of 28 workers who were trapped beneath, prompting the suspension of mining activity. Operations at the mine were suspended the next day and an independent investigation was ordered. While operations resumed after two weeks on May 28, a second accident after just two days resulted in the death of another worker, prompting the government to issue a shutdown order, barring maintenance activities. ((Freeport-McMoRan Copper & Gold Inc. : Freeport Indonesia ramping up output at world’s No.2 copper mine, 4-traders.com))

Freeport was finally permitted to resume open pit mining towards the end of June and has been running at full capacity since July 4. Underground mining has also resumed but might take up to a month to return to full capacity. The open-pit mine normally produces between 140,000-150,000 metric tonnes of ore per day while underground operations produce 80,000 metric tonnes. [3]

Before the accident, Freeport Indonesia’s sales volumes were expected to touch 1.1 billion pounds of copper and 1.25 million ounces of gold in 2013, an increase of 54% and 31%, respectively over 2012 figures. Each day that the mine remained shut, Freeport lost about 3 million pounds of copper (1,361 tonnes) and 3,000 ounces of gold in production. This amounts to nearly 3% of average daily global copper output this year. Since Freeport now expects to produce only 80% of annual targeted output this year, production of copper will be impacted by 220 million pounds and that of gold by 250,000 ounces. Given that May and June were the months most impacted by Grasberg shutdown, the second quarter results will bear the lion’s share of this brunt. ((Indonesia Completes Probe Into Freeport Grasberg Tunnel Accident, Bloomberg Businessweek))

In 2012, Grasberg produced 695 million pounds of copper, earning $2.5 billion in revenues and $850 million in gross profits. Total sales revenues from copper in 2012 stood at nearly $13 billion. [4]

The accidents at Grasberg are likely to have further ramifications for Freeport. The company is involved in pay negotiations with workers, and they latter are likely to demand higher wages as compensation for working in dangerous conditions. Freeport is also involved in talks with the government to extend its mining permit at Grasberg beyond 2021, when the current agreement ends. It may now have to cede some ground in these negotiations. We expect analysts to raise questions on these issues during the earnings conference call.

Freeport completed the acquisition of McMoran Exploration and Plains Explorations and Production in June. We expect the company to state consolidated financial statements and provide further guidance on the energy business in the conference call.

We have a Trefis price estimate for Freeport McMoran Copper of $42, which will be updated once the earnings results are released.

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Notes:
  1. LME Copper Prices, LME []
  2. China’s Q2 GDP growth likely to slow to 7.5%, Xinhua []
  3. Freeport-McMoRan Copper & Gold Inc. : Freeport Indonesia resumes underground mining, shipments, 4-traders.com []
  4. Freeport McMoran 2012 10-K, SEC []
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