March 26, 1996
Freeport McMoRan Copper and Gold (Symbol FCX, Exchange NYSE)
Number of Shares Outstanding: 202 Million Common Shares
Action: Buying Shares Buy up to $US 32.00 Target $US 40.00
Background: Freeport McMoRan Copper and Gold Inc. (FCX) owns the remote Grasberg property in Irian Jaya, Indonesia. This mine sits on the largest proven gold reserve in the world, and the world's third largest proven copper reserve. FCX has other operations, notably smelting and refining activities in Spain, but the Grasberg property is the very large jewel in the FCX crown.
FCX has been developing this mine since 1973. The early stages of the life of a major mine are typically associated with high risks and great capital requirements; the Grasberg property has demonstrated that it is well past this stage now. It is projected that improved efficiencies at the Grasberg site will almost double the mine's production in the next four years. At Grasberg the cost of extracting copper is extremely low. A cost of 60¢ per pound for extracting this metal is considered to be low by industry standards, at Grasberg the cost of extrating copper is just 20¢ per pound.
A major demonstration of confidence and injection of cash was recently provided by RTZ plc of Britain, the world's third largest mining company. RTZ will provide up to $US 750 million to improve production facilities at Grasberg and an additional $US 100 million for increased exploration. RTZ will receive 100% of the incremental cash flow generated by its investment until the amount of its stake is repaid, and 40% thereafter with the larger share, 60%, remaining with FCX. In earlier trading, RTZ acquired about 12% of FCX.
As well as the advantages of increased production which this investment will bring, the terms of the deal with RTZ are very favourable for FCX and are a tangible expression of confidence in the future of FCX by a major player in the field.
Opportunity: The Grasberg mine is a very large, well-established property with excellent future prospects. The mine generates a positive cash flow capable of retiring the debt incurred to bring it into production. Reserves are proven, government relations are excellent, knowledgeable investors have confidence in the company's operations and prospects.
While the proven reserves and present outlook are very good, the prospects for FCX are even better. Mining its proven reserves, the mine has a life expectancy of at least 45 more years and is secured by a Contract or Work with the government of Indonesia.
Using proven reserve figures and current prices for copper, gold and silver (Grasberg's third commercial mineral) the Grasberg find is conservatively valued at $US 50 billion. FCX is also prospecting over seven million acres in the region.
Preliminary prospecting results at Grasberg suggest that the current estimation of gold reserves could well be doubled from 40 million ounces to 80 million ounces. This possibility, coupled with the doubling of output as a result of the RTZ investment indicates a bright future for the Grasberg mine and therefore for Freeport McMoRan (FCX).
In the past, FCX has tended to favour issuing dividends commensurate with earnings. If this choice is made in the future, a dividend payment in the $US 2.00 per share range can be expected. Alternately, and depending largely on the results of exploration now underway, the company could choose to expand Grasberg even further, or to use its cash to develop other properties. In either case the implications for investors are very positive.
There are some risks associated with this property, and although they are more than offset by the positive features, they should not be overlooked. Grasberg is in one of the most remote locations in the world (see National Geographic, February 1996) and as with any mine, especially one of this size, there are environmental concerns. The company exceeds local standards of environmental protection and operates on modern North American guidelines. There are also social issues. Earlier this month (March 1996) an incident following the temporary disappearance of an injured local tribesman (company employees had taken him to hospital) actually caused a brief disruption in production at the mine.
The mine enjoys excellent relations with the stable Indonesian government. FCX is working with the government and local people in education, job training, agriculture and community development in a manner appropriate to the company's long term intentions in the area. Future incidents could conceivably cause price fluctuation in this stock, but not, I believe, enough to affect our investment strategy.
We have acquired shares of FCX in the $US 30.08 range.
Target: FCX is reaping the rewards of sustained exploration and development. Its production capacity will very likely double in the immediate future and its reserves could do likewise. The company's relationships with RTZ and with the government of Indonesia bode very well for the future. A minimum share value of $US 40 is a realistic expectation within one year.