Do Strong Freeport Earnings Suggest Growth In Basic Materials?

Chris Lau, Kapitall: Will basic materials stocks follow solid Freeport earnings, and bring big returns in 2014?

Interest in basic materials stocks wavered some this month as the sector's biggest rally of the year ended with the third quarter – and high prices seem poised to descend across the board in 2013.

Read more from Kapitall: Rebound in Basic Materials: 4 Undervalued Commodities Stocks to Consider

However, as earnings come in, interest appears to be back on the rise. Freeport-McMoRan (FCX) is one mining company that reported strong quarterly earnings and raised its outlook. We decided to take a closer look at Freeport to see if there might be other opportunities in the sector. 

Solid quarter

Freeport earnings included $0.79 per share on net income of $821 million. The company sold 1.04 billion pounds of copper in the third quarter, up from 922 million pounds. Freeport shares soared after results were announced: 

Click on the interactive chart to see quarterly sales over time. 

Sales likely missed the 1.06 billion target because output in South America was lower than expected. However earnings were bolstered on the back of rising gold sales up to 305K oz from 202K oz. Production from South America was lower than previously thought, but this was balanced by higher ore grades in Indonesia. 

Average realized prices for copper dropped to $3.28 per pound, compared to $3.64 per pound last year. Oil and gas production also contributed to solid results. Average realized price for oil was $104.33 per barrel.

Where the money goes

Freeport raised its operating cash flow guidance – a measure of of a company's income that's less susceptible to accounting tricks than profit or revenue – just slightly for the fiscal year. The firm expects operating cash flow will be nearly $6 billion.

This also comes at a time when the firm is actively reducing its capital expenditures (capex). Freeport wants to reduce capex by $1.9 billion this year. In the third quarter, capex was $1.6 billion.

Freeport expects capex to be $5.5 billion for 2013 with about a quarter of that to be spent on oil and gas operations (between June 1 and December 31 2013). That is a sizable portion, while projects at mining operations will cost $2.4 billion.

It's all about diversity

In an age when some commodity prices are fluctuating wildly, diversification is key. Since miners rely on high industrial output and construction to create a market for their goods – it's also important to pay attention where a company exports. One of the biggest miners in the world, Vale SA (VALE) exports almost half of its goods to China alone.

Click on the interactive chart to see data over time. 

Freeport’s diversification into oil and gas is starting to show signs of success. Revenue is higher compared to the previous year, and earnings are not as weak as investors feared. Freeport raised its debt levels, but has a healthy cash flow forecast that will likely be met to keep the balance sheet healthy. 

Bringing it all together

Investors already bid shares higher, pricing in the solid quarter and outlook. With the exception of Freeport, many miners are down this week. If prices continue to remain flat, or worse, fall – commodities companies could be in for a difficult year in 2014. And the short term fate Chinese economy will have a huge impact on share prices. 

Taken together, there are many intangibles that make raw material stocks look volatile right now. Investors may want to wait for a greater pullback before increasing positions in one of these companies. 

 

(Written by Chris Lau and James Dennin, Kapitall Writers. Quarterly sales and stock prices sourced from Zacks Investment Research, all other data sourced from Finviz.)

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