Freeport-McMoRan Inc. — Q3 2018 Form 10-Q
Business context and period. Freeport-McMoRan (FCX), a global copper, gold and molybdenum miner, reported unaudited results for the quarter and nine months ended September 30, 2018. Comparisons are with the corresponding 2017 periods unless stated otherwise. Amounts below are in U.S. dollars; financial statement amounts are in millions unless noted.
Financial performance and liquidity
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $4,908 | $4,310 | $14,944 | $11,362 |
| Operating income | $1,315 | $928 | $4,438 | $2,211 |
| Net income attributable to common stockholders | $556 | $280 | $2,117 | $776 |
| Diluted earnings per share | $0.38 | $0.19 | $1.45 | $0.53 |
| Operating cash flow | $1,247 | $1,183 | $3,925 | $3,012 |
| Capital expenditures | $507 | $314 | $1,391 | $1,020 |
- Operating margin was approximately 26.8% in Q3 2018 versus 21.5% in Q3 2017; for the nine-month periods it was 29.7% versus 19.5%.
- At September 30, cash and cash equivalents were $4.556 billion, total debt was $11.127 billion, and equity was $13.454 billion. FCX had no revolving-facility borrowings and reported about $3.5 billion of availability. The new unsecured $3.5 billion facility matures in April 2023.
- FCX reduced debt by approximately $2.0 billion in the first nine months. It repaid $1.4 billion of notes at maturity and redeemed $454 million of notes. Total debt was $13.117 billion at December 31, 2017.
- Cash dividends were reinstated in February 2018. Dividends declared totaled $0.15 per share in the first nine months; a $0.05 quarterly dividend declared in September was paid November 1.
Material changes and operating results
- Revenue rose about 14% in Q3 and 32% for the nine months. Higher copper and gold sales volumes—primarily from improved grades and operating rates in Indonesia—were major contributors. Nine-month results also benefited from higher average copper and molybdenum prices. Q3 realized copper and gold prices were lower year over year, while molybdenum was higher.
- Q3 copper sales were 1.044 billion pounds versus 932 million; gold sales were 837,000 ounces versus 355,000. Nine-month copper sales were 3.026 billion pounds versus 2.683 billion, and gold sales were 2.123 million ounces versus 969,000.
- Operating income increased, but production and delivery costs also rose. Q3 costs included $69 million related to Cerro Verde’s new labor agreement; 2017 comparison periods included $216 million of charges related to the Cerro Verde royalty dispute. Higher operating costs also reflected mining and milling costs in North America and Indonesia.
- Q3 and nine-month income included net gains on asset sales of $70 million and $126 million, respectively. The Q3 amount included a $50 million increase in the estimated value of Freeport Cobalt assets held for sale. Provisionally priced copper sales can materially affect revenue: prior-period pricing adjustments reduced revenue by $111 million in Q3 and $70 million for the nine months.
- Q3 copper production was 1.006 billion pounds versus 996 million; nine-month production was 2.972 billion versus 2.730 billion. Consolidated unit net cash costs were $0.93 per pound in Q3 and $0.95 for the nine months, compared with $1.20 and $1.25, respectively, in 2017; these are non-GAAP operating measures.
Outlook, management commentary and risks
- Management projected 2018 sales of 3.816 billion pounds of copper, 2.453 million ounces of gold and 95 million pounds of molybdenum. Q4 sales were expected to be about 790 million pounds of copper, 330,000 ounces of gold and 25 million pounds of molybdenum.
- At assumed Q4 average prices of $2.85 per pound copper, $1,200 per ounce gold and $12 per pound molybdenum, FCX estimated 2018 operating cash flow of approximately $4.2 billion, including $0.5 billion of working-capital uses and timing of other tax payments. Estimated 2018 capital expenditures were approximately $2.0 billion, including $1.2 billion for major projects. These are forward-looking estimates, not reported results.
- FCX described its long-term copper outlook as positive but emphasized exposure to volatile commodity prices. Management expected copper unit net cash costs of about $1.06 per pound for 2018 and a consolidated effective tax rate of about 37%, subject to stated assumptions.
- Indonesia transaction and license risk: FCX agreed to sell its interests in PT Indocopper Investama to state-owned PT Inalum for $350 million; Inalum separately agreed to acquire Rio Tinto’s joint-venture interests for $3.5 billion. Pending completion, FCX expected to own 48.8% of PT Freeport Indonesia (PT-FI), retain management, and share project economics under agreed arrangements. Closing, expected in late 2018 or early 2019, depended on Indonesian mining-rights documentation, environmental and other regulatory resolutions, and other approvals. PT-FI’s temporary mining license was effective through November 30, 2018, and its export license through February 15, 2019. FCX’s projections assume mining-rights or temporary-license extensions.
- PT-FI committed to build a smelter within five years after closing. Environmental decrees impose standards FCX considers unattainable; the filing warned that failure to modify or delay them could adversely affect operations, including possible shutdown. The Grasberg open-pit-to-underground transition is expected to reduce Indonesia production in 2019–2020 before an anticipated recovery. Underground development, seismic activity and project cost or schedule overruns are additional risks.
- Contingencies: FCX had recorded cumulative Cerro Verde royalty-dispute charges of $487 million. It had not recorded potential penalties and interest of $406 million for 2009–2013, believing waivers should be obtained; payment demands for part of the period were received in October 2018. PT-FI also had unrecorded surface-water assessments estimated at $173 million and potential income-tax penalties estimated at $212 million; these matters were disputed. A California wage-and-hour class action had an estimated potential exposure of $60–$100 million if state law applied retroactively; FCX had not recorded a reserve because it did not consider a loss probable.
- FCX reported 12 additional shooting incidents in the PT-FI project area and nearby areas during the first nine months, resulting in five injuries. The filing also noted environmental obligations, commodity-price risk and development-project execution risks. Management stated there were no material changes to contractual obligations since year-end.
Most important facts for investors to verify
- Whether the PT-FI divestment closes on the stated terms and whether mining rights, export permissions and environmental requirements are resolved.
- Grasberg underground transition timing, production ramp-up, project spending and the expected 2019–2020 production decline.
- Actual commodity prices, sales volumes, unit costs and cash flow versus management’s 2018 assumptions; monitor provisional copper pricing exposure of 373 million pounds, for which a $0.05-per-pound price change was estimated to affect 2018 common-stockholder net income by about $11 million.
- Developments in the Cerro Verde royalty dispute, Indonesian tax and surface-water disputes, and the unreserved California litigation exposure.
- Debt reduction, liquidity, capital expenditures and dividend decisions. The interim statements received an independent accountant’s review, not an audit; management reported disclosure controls were effective as of September 30, 2018.