The Impact Of Copper Supply Side Constraints On Freeport’s Stock Price

Freeport-McMoRan Inc. (NYSE:FCX) is one of the world’s largest producers of copper. Though the company diversified into oil and gas in 2013, copper mining is still the mainstay of its business, with the sale of copper accounting for 60% of its consolidated revenues in 2014. ^[1] Thus, the company’s fortunes, to a large extent, are determined by the trajectory of copper prices. Copper prices fell quite considerably over the course of the last year, with London Metal Exchange (LME) copper prices averaging roughly $5,800 per ton in Q1 2015, as compared to approximately $7,100 per ton in Q1 2014. ^[2] The decline in copper prices over the last year was mainly due to concerns over copper demand from China, due to recent signs of economic sluggishness. China is the world’s largest consumer of copper, accounting for nearly 40% of the world’s demand for copper. ^[3]

However, after falling to levels of $5,400 per ton in January, LME prices have recovered somewhat, and currently stand at levels of $6,000 per ton. Prices have been bolstered by improving economic conditions in the developed world, particularly in the U.S., and to a lesser extent, in Europe and Japan. ^[4] Another factor that has contributed to the recovery in copper prices are supply side constraints, with several companies abandoning or deferring new projects, which has raised expectations of future copper prices. In this article, we will take a look at what impact this could have on Freeport’s stock price.

Impact of Supply Side Constraints on Freeport’s Stock Price  

Copper Prices

(Copper Prices, Source: London Metal Exchange)

Copper prices have been boosted by expectations of the tightening of copper supply. ^[5] As a result of the prevailing weakness in prices over the course of the last year, large copper mining companies have put on hold several new projects. In addition, given the adverse pricing environment, funding has become hard to come by, especially for smaller copper mining companies. ^[5] Furthermore, declining ore grades have negatively impacted copper output for many copper miners globally. ^[5] As a result of these supply side constraints, copper output is expected to decline, which is likely to translate into a more favorable demand-supply equation. However, the exact impact of these supply side constraints on the demand-supply equation remains to be seen. As per estimates by Citi, demand for copper will exceed supply by 61,000 tons by 2016. ^[5] Though this represents less than 1% of global production, the extent of this supply shortage could increase going forward, particularly if global economic growth recovers faster than expected. ^[6] This would boost copper prices and the prospects of copper producers such as Freeport.

In order to model this scenario, we will assume that realized copper prices rise 10% by the end of our forecast period. This would correspondingly boost margins for all of the company’s copper mining divisions. In addition, we will assume that the company’s production plans and capital expenditure remain the same in this alternative scenario. Since we forecast capital expenditure as a percentage of EBITDA, in order to model this new scenario we have modified our forecasts in order to keep capital expenditure at the same absolute levels in the new scenario. If we factor in these assumptions on the various drivers impacted in our stock price model, our price estimate for Freeport increases by about 39% from $21.62 to $29.96. Thus, there is significant potential for an upward revision in valuation for Freeport in case supply side constraints boost copper prices.

See our complete analysis for this scenario

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1. Freeport-McMoRan’s 2014 10-K, SEC [↩]
2. LME Copper Prices, LME [↩]
3. Copper Ends at 5-Month Low on China Worries, Wall Street Journal [↩]
4. Copper Rebound Seen by Barclays as Miners Struggle on Output, Bloomberg [↩]
5. Copper producers position for price recovery, Financial Times [↩] [↩] [↩] [↩]
6. Global Copper Production, U.S. Geological Survey [↩]