There's trouble at the world's largest copper miner, Chile's Codelco, and that's good news for long-range copper prices and for the world's second-largest copper miner, Freeport McMoRan Copper & Gold
). (Freeport McMoRan is a member of my Jubak's Picks portfolio.)
On May 25, Diego Hernández resigned as chief executive of Codelco in apparent frustration with the bureaucracy at the company owned by the Chilean government. In a long interview with La Tercera, a Chilean newspaper, Hernandez said he could no longer tolerate the intervention of Codelco's board of directors in day-to-day management.
Hernandez, who moved to Codelco from BHP Billiton
) in 2010 to become the first Codelco CEO with a background in mining, had pushed through an ambitious investment plan that would have added 1.3 million metric tons of new production at the company by 2020. Much of that new production -- 1 million tons -- would simply replace declining output from the company's older mines. On April 17, Hernandez had said that Codelco's production would slump to 800,000 metric tons from the current 1.7 million tons if the company didn’t invest $20 billion over the next decade.
Codelco doesn't exactly have a history of aggressive investment, which isn't surprising once you undertstand how the government-owned company works. The company pays all profits to the government. To reinvest any of its profits the company must make an annual proposal. But Hernandez had been able to successfully argue for increased re-investment given declining production from older mines.
The question now is what happens to that investment program. The Ministro Hales project is scheduled to begin production at 160,000 tons in 2013. That project is unlikely to slip with the CEO’s departure.
But two of Codelco's biggest projects are also incredibly challenging. At Chuquicamata, Codelco is working to convert the current enormous open pit mine into an enormous underground mine. The Andina project is at high altitudes where working conditions (including glaciers) make work difficult and slow. The two products, scheduled for 2018 and 2019, will produce 650,000 tons of copper annually. I’d expect actual or projected rising costs, which might well damp Codelco’s zeal for pursing these projections
How does any shortfall at Codelco help Freeport McMoRan Copper & Gold?
During the current slowdown in global growth, shortfalls in copper supply have supported copper prices. When demand picks up again in the second half of 2012 or in 2013, depending on how fast China stimulates its economy, copper will face a significant supply/demand gap, which any shortfall at Codelco will only make worse. Freeport is one of the few copper companies with a pipeline of relatively low cost projects likely to add to production in the near term. For example, Credit Suisse projects that the company will increase production by 4.7% in 2014.
Right now I think Freeport McMoRan is cheap. The stock has been hammered -- shares are down 34% in 2012 -- on fears that a slowdown in China will crush global demand for copper and on worries that the Indonesian government will nationalize the company’s huge Grasberg mine (or impose higher payments.)
The effects of a slowdown in China on global copper demand are certainly real -- it’s a major reason that Freeport McMoRan’s realized copper price has tumbled from $4.31 a pound in the first quarter of 2011 to $3.82 in the first quarter of 2012. But thanks to the supply shortfall, it looks like copper prices may have stabilized.
The fears about Grasberg look to be overstated. The company has released the terms of its existing contract of work for the mine, which indicates that the existing contract runs through 2021 and that the current contract already requires higher payments to the government than are required under new law.
Don’t buy Freeport McMoRan if you’re not prepared to be patient -- the stock isn’t going to move up strongly until investors can clearly see a bottom in China’s economic growth. (I expect to see that bottom in the third quarter of 2012.) But the shares do pay a 3.8% dividend currently and the upside is very attractive. I calculate a 12-month target price of $61 a share for Freeport McMoRan. (That’s down from my previous target price of $70 a share in my Jubak’s Picks
At the time of this writing, Jim Jubak didn't own shares of any companies mentioned in this post in personal portfolios. The mutual fund he manages, Jubak Global Equity Fund (JUBAX), may or may not own positions in any stock mentioned. post. The fund did own shares of Freeport McMoRan Copper & Gold as of the end of December. For a full list of the stocks in the fund as of the end of the most recent quarter, see the fund's portfolio here.