Freeport-McMoRan Inc (FCX) — Q2 2016 Earnings Call Transcript

Thank you. Good morning, everyone and welcome to the Freeport-McMoRan second quarter 2016 earnings conference call. Our results were released earlier this morning and a copy of the press release and slides for today's call are available on our website at fcx.com. Our conference call today is being broadcast live on the Internet, and anyone may listen to the call by accessing our website homepage and clicking on the webcast link for the conference call. In addition to analysts and investors, the financial press has been invited to listen to today's call and a replay of the webcast will be available on our website later today. Before we begin our comments, we'd like to remind everyone that today's press release and certain of our comments on the call include forward-looking statements and actual results may differ materially. We'd like to refer everyone to the cautionary language included in our press release and presentation materials and to the risk factors described in our 2015 Form 10-K and subsequent SEC filings. On the call today are Richard Adkerson, Chief Executive Officer of FCX; and Red Conger, President of Americas and Africa. I'll start by briefly summarizing the financial results, and then turn the call over to Richard, who will review our recent performance and outlook. As usual, after our remarks, we'll open the call up for questions. Today, FCX reported a net loss attributable to common stock of $479 million, or $0.38 per share for the second quarter of 2016. As detailed in the release, the net loss attributable to common stock included a special item totaling $452 million, or $0.36 per share during the second quarter, primarily for the previously reported drillship settlements and impairment of our oil and gas properties, partly offset by net gains on the sale of assets. After adjusting for these net charges, our second quarter adjusted net loss attributable to common stock totaled $27 million, or $0.02 per share. Adjusted earnings before interest, taxes, depreciation, and amortization for the second quarter of 2016 approximated $966 million. During the second quarter, we completed previously announced asset sales for aggregate consideration of $1.3 billion, including the $1 billion sale of the additional 13% undivided interest in Morenci during May. And also in May, we entered into a definitive agreement to sell our interest in TF Holdings Limited for $2.65 billion in cash and contingent consideration of up to $120 million. Our consolidated sales volume totaled 1.1 billion pounds of copper, 156,000 ounces of gold, 19 million pounds of molybdenum, and 12.4 million barrels of oil equivalents. The average price of copper was $2.18 per pound, which was below last year's second quarter average of $2.71 per pound. Gold averaged $1,292 during the quarter, which was above last year's quarterly average of $1,174. Our realized price for crude oil of $41 per barrel was below last year's quarterly average price of just under $68 per barrel. Unit net cash cost for the quarter averaged $1.33 per pound, which was lower than the year-ago period of $1.50 per pound, primarily reflecting the higher copper volumes and economies of scale we've achieved during the quarter, alongside the impact of ongoing cost reduction initiatives, partly offset by lower gold and silver credits. We generated operating cash flows during the quarter of $874 million, which exceeded our capital expenditures of $833 million during the quarter. As previously reported, we exchanged some of our senior notes into equity through July 25. Yesterday, we exchanged a total of $369 million in face amount of bonds at a cost of $311 million, or approximately 28 million shares of our common stock, in a series of privately negotiated transactions. Our debt at the end of June was $19.3 billion and consolidated cash was approximately $350 million. We ended the quarter with no borrowings under our $3.5 billion revolving credit facility, and currently have approximately 1.33 billion common shares outstanding, which includes the shares issued through yesterday in connection with the debt exchange. I'd now like to turn the call over to Richard, who'll be referring to our slide materials and discussing our operations and outlook.

Thanks, Kathleen, and thank you all for joining us today. I'd like to step back a moment and look at our overall situation a bit before we turn to the quarter. We have some important facts and situations to discuss regarding the quarter, and we'll cover those in detail. However, I believe it's important for you to understand that we feel very positive about the progress we've made during the first half of the year. Late last night, as we put the finishing touches on today's presentation, Kathleen and I reflected on where our company stood a year ago. A year ago, oil prices were in the mid-$60s a barrel, copper prices were around $2.70, and we were discussing controlling costs as well as strategic alternatives for our oil and gas business. As 2015 proceeded into 2016, oil prices dropped at one point below $30 a barrel, and copper prices fell below $2 a pound. There were a lot of uncertainties surrounding our company due to our debt level, as evidenced by how our bonds and CDSs traded. We took steps to reorganize our board, emphasizing our focus on the future of our company in the mining business, and we restructured our management team. We took action. During our year-end earnings call, skepticism surrounded our ability to execute the plans required to address our balance sheet issues. Internally, there was uncertainty about how we would achieve our goals and how the market would react. We committed to sell assets and raise capital, targeting $5 billion to $10 billion, and we went to work. Meanwhile, Red and his team, along with our global operating teams, focused on executing our business plans. As you look at the charts on slide three, you can see how effective we've been in reducing our site production and delivery costs by 23%. In our oil and gas business, we cut production costs from $19 a barrel to $15 a barrel. We completed our major expansion project at Cerro Verde, which a year ago was a significant risk for our company. This project was the largest processing facility in the history of the mining industry and cost over $4.5 billion. We reduced CapEx across the board, and we undertook asset sales in a challenging market. Our approach was to strengthen our balance sheet, and surprisingly to many, we were able to achieve valuations that reflected a positive view of the long-term copper market. Today, we've raised over $4 billion, all by selling only 9% of our copper reserves. The efforts made to sell our oil and gas business were conducted during a tough market, and we strategically restructured the business to operate within its cash flows, dealing with commitments made during more aggressive growth periods. Our copper volumes grew with the successful startup of Cerro Verde, experiencing a 15% quarter-to-quarter increase. We believe our company has truly turned the corner, and we're determined to prove that our assets are attractive. Our financial strategy aligns with our long-term business strategy; we are committed to retaining a core set of assets to build long-term value for our shareholders. While it may be tempting to sell assets simply to raise cash, we've maintained our focus on what Freeport will become in the long run and which assets will best facilitate our core competencies and enable us to capitalize on what we believe to be a long-term positive copper market. Looking at slide four, we have targeted reducing our debt to $10 billion. Our debt as of June 30 is just below $19 billion, and we are working on a contract to sell our Tenke asset along with related assets for approximately $2.8 billion. If we project different scenarios for copper prices with a successful execution of our plans, we estimate what our debt levels could be at $2 copper, $2.25 copper, and $2.50 copper by the end of 2017. While this reflects transactions we've already completed, it does not take into account divesting shares of PTFI. We aim to work with the Government of Indonesia to sell approximately 20% of PTFI, contingent on contract extensions. We will continue to consider further strategic steps, such as additional asset sales of our oil and gas business. I want to emphasize that any potential divestment of PTFI will only occur at a fair valuation for our company. We acknowledge the risk associated with copper prices potentially declining due to slower growth in China and global economic uncertainties. Therefore, we face a balancing act: understanding our operational requirements to mitigate these uncertainties while keeping our sights on long-term growth. We need to be flexible and open to all strategic moves to create value for our shareholders. Our recent history shows the importance of maintaining a strong balance sheet to allow us to navigate and leverage long-term value. We're engaged in ongoing discussions about additional asset sales, assessing capital market transactions. Today, we've announced plans to file necessary documents to enable us to raise another $1.5 billion through an at-the-market offering. We've had success with these offerings in the past during times of crisis and have conducted two last year when financial conditions were more uncertain. This allows us to access the marketplace, to assuage demand for our shares when available. Looking at these numbers, we see a clear path forward, absent any drastic market collapses. We have now a defined route to achieve our financial goals, enabling us to retain our highest-quality assets for future company growth. The transactions noted on slide five relate to the successful sale of an incremental 13% interest to our valued partner Sumitomo in Morenci. This transaction is already closed. We've also initiated a series of smaller transactions, and the Tenke Fungurume transaction is progressing smoothly through necessary regulatory steps in China. The reports indicate this transaction is anticipated to close in the fall. This will generate between $4 billion and $4.5 billion for us. So, what remains for Freeport? We have a prime set of assets, including seven copper mines led by our flagship Morenci mine in North America, two molybdenum mines with a solid business, and two mines in South America: Cerro Verde and El Abra, where we are working on potential major expansions only when market conditions allow. Evaluating our potential transactions and buyer interest has reinforced how much value we can create by keeping these assets together to leverage shared resources, technology, and equipment. We'll maintain flexibility to focus on growth and continue executing rational business strategies. Our growth pipeline for the copper industry is robust, extending far into the future. Importantly, we maintain the ability to approach low-risk, executable transactions rationally and profitably. We’re focused on generating profits and long-term growth in a financially disciplined manner. As we review our properties, we examine operational strategies to optimize production while keeping capital expenditures low. We're exploring steepening the walls of our operating pits to minimize stripping and recover additional ores without significant capital investments. This approach aligns with our commitment to balance safety norms. We’re at a crucial phase of transitioning from the open pit at Grasberg to the underground mining of the Grasberg Block Cave. Progress on this project is progressing as planned. We're transferring production underground to ensure a continuous ore supply post-pit completion. The completion of the Grasberg open pit is projected for early 2018. This quarter, we've experienced some operational challenges, including mechanical repairs and workforce grievances, impacting production volumes. I want to emphasize that while production volumes were impacted, the valuable ore remains and will be extracted in the future. Our Indonesian government has assured us regarding obtaining necessary export permits, expected by the first week of August. Additionally, we’ve seen constructive discussions regarding our contract extension ongoing with senior officials, which has improved our outlook for positive resolution. Our mining operations remain healthy; we've achieved significant EBITDA relative to our capital spending, even with lower copper prices. Overall, our financial position continues to improve. Operational cash flows at $2.25 copper are projected to be $4.5 billion with substantial leverage. As we look forward, we've lowered our capital expenditures while optimizing production volumes and have secured plans to retire debt as needed moving forward. As we plan for the future, we've set targets for copper and gold production, which will progress through 2017, with challenges arising from ongoing restructurings in Indonesia. Our company is positioned to build on a competitive edge and execute effectively, ensuring growth potential and value for our shareholders as we navigate market fluctuations. Thank you for your attention, and I look forward to your questions.

Hi, good morning. I was wondering if we could get a bit more color on Grasberg, specifically your five-year outlook for production really hasn't changed that much the last couple quarters. I'm just wondering how we should think about that production profile as you differ CapEx spending given the uncertainty on the COW extension. I mean at some point I would think that's going to have some impact on that, sort of post 2017 outlook, any color there would be extremely helpful. Thank you.

All right, Orest. Yeah, that's a good point. While we have found some ways and we continue to search for ways to defer capital, we changed the mine plans and have done certain things. What we have not done yet is defer the necessary steps that would allow us to begin ramping up the Grasberg block cave production once the pit is completed, which would be early 2018. The balancing act has been our major focus in the first half of the year. I went to Grasberg, sat down with our team, and did a detailed review of what it would mean if we were to defer the spending of the $1 billion a year that we’ve been spending recently to develop this underground resource. What would happen would result in significant layoffs and social disruptions that concern us. If we don't proceed, there will be a negative impact on the ramp-up of the Grasberg block cave. Therefore, we've been gathering assurances from the government regarding our contract extension, which supports our plans for the future.

Is there a specific sort of drop-dead date in your mind that if you don't receive the COW extension by a certain point in time, you will sort of be forced to pull back the CapEx spend?

There are some important dates for us. One is this August 8, for obtaining our export permit. We've been assured we'll get that. Additionally, there is a government regulation prohibiting exports beginning in January 2017, which will need to be changed. If they don't, that becomes a major trigger point for us. Our contract provides that if the government acts in ways that conflict with our contract, we may have legal rights to pursue damages. We prefer not to, as we want to work cooperatively with the government.

And just as a quick follow-up. The reduction in Africa sales guidance for copper this year, does that reflect an actual reduction in your volume or is that just the closing date affected by the closing date of 10-K, i.e., you think it's going to close before year-end?

Yeah. That's what it is. We've forecasted for a fourth-quarter kind of middle closing date. So, we've just forecast what we would have through that closing date.

The second quarter was a record and I think we've never produced more copper in a quarter than we did last quarter.

Thank you, Red. In terms of operation, things are going great. Our team is cooperating well, and our work with China Moly as we plan transition is going very well. China Moly is committed to maintaining the quality of operations, environmental standards, and social programs.

Hi, guys. Just had a couple of questions on operations and the balance sheet. Maybe just start on slide four, where it’s good to get the progression in the net debt. Does that include the $1.5 billion equity raise, just to be clear on that?

No, it does not. And it does not include ATM proceeds or any sale of oil and gas assets, nor does it include any sale of additional shares in PT-FI.

Okay. Thanks very much. And then just I guess a broader question on your CapEx and cost reduction targets you’ve been able to achieve. You mentioned another $150 million, could you step through how you look at 2017 and beyond, and whether cuts now in CapEx would need to be caught up in 2018?

Well, the $150 million you referenced is a cut in non-capital costs within our oil and gas group, encompassing G&A and other related expenses. This reflects a major reduction in employment in that sector. We’ve been tough on managing costs in our mining business for some time. Over time, we may have to increase some capital in maintaining facilities, but other than the necessary investments in the Grasberg project, we don’t foresee major new capital projects until the market warrants it.

And we managed the CapEx budget down from $3.3 billion to $3.1 billion in 2016, targeting a slight increase for 2017. We're continuing to emphasize deferring spending in this market environment, aiming for both sustainable long-term capital savings moving forward.

And we had all of our mine managers work together last week, and we have a great team dedicated to achieving our objectives.

Okay. Thanks for the color. And just one final question. If we look at the tone of the conversation over the last three months, it seems to be moving towards completing the equity raise and not necessarily needing to pursue another asset sale. Is that the right way to interpret that?

Yes. We began the year stating that every asset we had was up for consideration for sale, and we've made progress. While we continue having discussions, we also have established clarity that we didn't have before, allowing us to potentially move forward without further asset sales.

Hey, good morning, Richard and Kathleen.

Hey, Evan.

So, first question just on 10-K. I was hoping you could address a couple of issues with the closing, one is DRC's objections to the deal. Do they have any legitimate claims and what might that cost if anything?

We've built a great relationship with the DRC government as we've operated Tenke Fungurume Mining. We've had initial rocky relations, but our partnership with Gécamines has significantly improved. We've had positive discussions with China Moly, who is taking steps to reassure Lundin and others concerned. The government is seeking financial compensation out of this, but legally, there's no basis for anything other than continuing our operations as planned.

Okay, thanks for that. And second question just on leverage, if you roll that forward into 2018, what is the debt level you want to achieve from a net debt perspective?

We anticipate generating cash flows, even with Grasberg’s lower volumes in 2018. We will evaluate necessary debt levels based on market risks at that time. Our aim would be to return to shareholder dividends after stabilizing our balance sheet once we achieve our goals.

Richard, Kathleen, thanks very much for the update. Just a couple of questions. First on gold at Grasberg, I see it is heavily weighted to Q4 this year. We think grades will have to jump significantly. Can you speak to the distribution of that grade into 2017, will it be evenly spread or loaded?

There will be quarter-to-quarter variability, and a slight change can have significant effects. However, we anticipate a strong quarterly gold volume throughout 2017, with some variability.

This variability has been discussed beforehand, especially since we designed pit limits with future access in mind.

On CapEx guidance for 2017, does that include Tenke, or has Tenke been taken out?

Yes, we’ve already scaled down CapEx for Tenke in 2017 to only a few million, following completion of the asset plan this year.

We did not anticipate significant capex from Tenke.

Hi, Richard, Kathleen, and Red. I wanted to start off with a question on oil and gas. I see the U.S. Bureau of Ocean Energy Management has set some new requirements regarding plugging and abandonment liabilities. Can you discuss the implications, does this shrink the pool of potential acquirers?

That’s a good question, Tony. These new rules were initiated last year, but how they will be enforced remains unclear. We're monitoring this and preparing to cooperate with the government on these regulations. This growing emphasis worldwide could impact potential buyers, especially smaller or financial companies, as opposed to established operators.

Understood. I want to ensure I understand a comment you made regarding not being required to pursue further asset sales, did you mean to include oil and gas?

Correct. While we view asset sales as potential strategies, we’re not mandated to engage in them strictly to meet financial objectives. We've established a path to achieve our targets that we are content with.

Has there been any change in tone from the government, considering Newmont announced it will sell its Indonesian assets?

We’ve had a positive tone from senior officials for quite some time now. The Indonesian government has been discussing the importance of fair treatment for existing investors during ongoing evaluations.

Thank you very much for taking the question and congratulations on the recent profit. Could you speak a little more about the six copper sulfide projects you’re studying, particularly El Abra and the five in the U.S.?

Sure. Starting with El Abra, it's a large, low-grade deposit, which we’ll need substantial processing capacity for. We need to focus on our core drilling and exploration analysis, which complements the current situation at our other U.S. operations, like Morenci and Chino. Lone Star is emerging as promising due to access to a substantial sulfide resource, which we can develop without significant capital expense. We are being disciplined about our investments, as we prepare for the future.

Hi. I have a question regarding slide 16, when you talk about the CapEx profile for the oil and gas business. I guess, what is the sustainability of the EBITDA run rate with that level of $600 million in CapEx?

That's what we're spending time on in our Houston team. We've had cash flows from wells drilled since acquiring Plains, which defer declines while investigating lower-risk options for managing those patterns. The challenge is ensuring we balance production needs with reinvestment in the long term.

Okay. If a buyer emerges willing to run the assets at those cash flow levels, will you maintain the optionality of keeping those reserves in the ground?

You'll need ongoing investments, driven by partner commitments and lease requirements. While we have some time, we must be strategic about how to continue the business and maintain inventory.

We’ve realigned our oil and gas operations in a way that doesn’t impose strict commitments while allowing our team to develop capital strategies that protect values and manage investments sustainably.

We will be transparent in updating you on our progress as we assess and decide on where to allocate capital.

Hi. Thanks for taking my questions. I may have missed it but what was the reason for the roughly 16% decline in guidance for oil, compared to three months ago?

This had to do with three new wells that were drilled at Holstein Deep. Unfortunately, the quality, permeability, and viscosity of the oil were different from what we expected. These wells were anticipated to produce significantly more volume than they currently are, resulting in decreased guidance.

In addition, the sale of the Haynesville gas affected volumes, but not cash flows. This was reflected in reported barrel equivalent calculations.

Many firms use industry standards, which have not performed as anticipated post-acquisition. We’ve had no cash flows from Haynesville thus far.

Okay, that’s helpful. As you look to the future, particularly 2018 and beyond, can you explain the expected growth sources, considering the completion of Cerro Verde and Morenci expansions?

That’s influenced by market conditions. Should copper markets reward growth, we wouldn't feel compelled to engage in investments unless justified by sustainable returns. Our focus will be on generating shareholder value through prudent capital allocation in the long run.

Hi, thanks for taking my question. Richard, I want to revisit your comments on being open to different scenarios and options, including the potential sale of the company. Is there a specific process underway for that or is this more of a consideration if an attractive offer arises?

Yes, there are legal obligations that our public company board must address. Additionally, our commitment lies in creating shareholder value, leading us to explore reasonable options as they present themselves.

That’s very helpful. Just a quick follow-up. The $1.5 billion ATM is intended to address ongoing indebtedness. Is there a specific focus such as shorter maturities for these proceeds?

No, it’s part of an overall management approach. We have secured plans to cover our 2017 maturities and that will factor into managing our 2018 debt landscape.

Good morning, everyone. Richard, earlier in the call you mentioned trigger dates in Indonesia, I wondered if you expect progress on the smelter and divestiture in the coming six months?

Those two are part of a package of resolving our contract situation. We cannot build a smelter without a contract extension. We’ve had a positive outlook on those negotiations lately, which reinforces our path going forward in the region. We're open to divesting some shares of PT-FI but that depends on a contract extension being finalized.

Got it. That’s helpful. Thank you. Moving forward, do you have a timeframe for issuing your 2018 production outlook?

We disclose a five-year outlook for Grasberg. While we will update our expectations, we have not yet established a date for finalizing the complete 2018 guidance, but the most pronounced impact will stem from Grasberg.

These projections must be understood in context; we would not have expected exceptional production years such as 2016 and 2017. The asset remains strong and viable into the future.

We could go on forever, and some might say that indeed we have today. Thank you for the attention, and we remain available for any future follow-up questions.