Revising Freeport Estimates to $42, China Demand Still Driving Growth

Freeport McMoran Copper’s (NYSE:FCX) profitability from copper sales will be robust in the near term as we expect that Chinese importers will restock their copper inventory, allowing for a recovery in the price of copper. While we expect the price of copper to improve in the near-term and reach over $4 per pound in 2012, the increasing production may eventually result in oversupply, pushing prices down longer term. ^[1] In light of these pricing dynamics, we have revised our price estimate for Freeport’s stock from $57 to $42, which is still about 20% above the current market price.

Freeport McMoran has extensive copper mining and smelting operations in North and South America, Indonesia and Africa. The company competes with other miners such as Southern Copper (NYSE:PCU), Codelco and Newmont Mining (NYSE:NEM).

See our complete analysis of Freeport here.

Near term upside to copper price after recent declines…

Copper had a steady bull run over the past two years on account of the demand-supply gap. The metal reached an all-time high in February of this year but has corrected more than 11 percent since then. The Chinese demand saw a decline in the past few months as Chinese importers started clearing their copper inventory, leading to a slump in prices.

We expect Chinese demand to pick back up by the end of the year, which will lead to a significant shortfall this year. We believe that this trend will continue until the latter part of 2012 owing to strong demand from construction and electricity projects. We estimate that the copper price will be northbound during the remaining part of 2011 as Chinese importers begin re-stocking their inventory. A Goldman Sachs analyst expects the price to peak at $4.25 per pound by the end of 2012. ((ref:1))

… but long-term production increases will push prices back down

Miners are pushing hard to increase their copper output in order to take advantage of the current market price, which is still relatively high. Selling copper at $2 per pound is profitable for the miners, so a price above $4 guarantees significant returns.

With additional capacity kicking in over the next 4-5 years, we may eventually see supply outpacing demand, which would result in oversupply and a consequent decline in spot market prices. We estimate that the copper price may fall below $3 per pound by the end of 2015. With shipment numbers staying constant and the market price going down, both revenues and margins will take a hit.

Refer to our recent note on the copper price outlook: Copper Prices Set to Recover Lifting Freeport, Others

In the long run, Freeport’s margins may see a decline. However, since the company still enjoys a gross margin of more than 50 percent across many of its divisions, we believe that the company’s fundamentals will remain strong and that there is substantial upside to the current stock price.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. Copper price outlook is favorable: Goldman analyst, Marketwatch [↩]