Why did FCX's earnings decline sharply in 1998 despite record production?

Production and sales volumes rose substantially, with PT-FI copper sales up 19% and gold sales up 16%. However, average copper realizations fell 22% to $0.73/lb, and gold realizations fell 16%, reducing PT-FI revenues to $1.35 billion from $1.51 billion. Lower metal prices outweighed the volume gains and cost savings, reducing operating income 14% to $574 million.

How did FCX change its capital allocation and shareholder returns?

FCX repurchased 20.0 million shares for $259.4 million in 1998, bringing cumulative buybacks to 50.2 million shares for $1.03 billion, with 9.8 million shares remaining under authorization. In December 1998 the Board eliminated the regular quarterly common dividend (previously $0.05/quarter), citing low copper and gold prices and a goal of reducing debt. Preferred dividends continue to be paid.

What are the main risks to investors from Indonesia?

All mining operations are in Indonesia's Irian Jaya province. Risks include the political transition following President Suharto's May 1998 resignation, parliamentary elections in June 1999 and a presidential election in September 1999, rupiah volatility, and sporadic separatist conflict and human rights allegations. The company also faced a wildcat work stoppage at Grasberg in August 1998, and the union contract expires September 30, 1999. Management says Indonesia's Contract of Work protects against nationalization and that disputes go to international arbitration, but that social and political instability could have a material adverse effect.

How significant is FCX's debt burden and how is it being managed?

Long-term debt including current portion and short-term borrowings was $2.46 billion at year-end 1998, up from $2.39 billion. Interest expense, net, rose to $205.6 million from $151.7 million, largely because of expansion financing and share purchases. Management expects lower debt and interest costs in 1999 through operating cash flow, the dividend elimination, and lower capital spending of roughly $185 million. Note that the company stated that new capital, if available, would be costly.

What is the outlook for FCX's production and costs in 1999?

PT-FI expects 1999 copper sales of approximately 1.4 billion lbs and gold sales of about 2.1 million oz, with higher mill throughput offset by lower ore grades and recoveries. Treatment charges for much of 1999 volume were negotiated lower. The 1999 depreciation rate is expected to rise to 18.0 cents/lb from 17.0 cents, and the FCX/Rio Tinto exploration budget is about $17 million. Reserve estimates would fall roughly 9% for copper if prices dropped to $0.75/lb.

FCX 10-K FY1998 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 19, 1999. Cited figures are marked; the original filing is the authoritative source.

Freeport-McMoRan Copper & Gold (FCX) reported a difficult 1998 as low copper and gold prices, a sharp Indonesian economic downturn, and a 47%^a cost reduction at its Grasberg operations in Irian Jaya squeezed results.

Consolidated revenues fell 12% to $1.76 billion^b from $2.00 billion, and operating income dropped 14% to $574 million. Net income applicable to common stock fell 43% to $118.3 million, or $0.67 per share, from $208.5 million ($1.06 per share) in 1997. Copper realizations fell 22% to $0.73 per pound, while PT-FI's record throughput of 196,400 metric tons of ore per day and 1.43 billion pounds of copper production (up 22%) partly offset the price decline.

Cash production costs fell to $0.12^c per pound, the lowest in the filing's history, which supports management's claim that FCX is the world's lowest-cost copper producer. The balance sheet is the main investor concern. Stockholders' equity fell to $103.4 million from $278.9 million after $259.4 million of share buybacks, and total debt (including the Rio Tinto note) remained around $2.5 billion.

Management responded by eliminating the common dividend in December 1998 and stating an intent to reduce year-end 1998 debt significantly during 1999. Interest expense rose to $205.6 million^d, and the company said capital availability is limited and new capital would be costly given Indonesia's political and economic instability. Key risks include Indonesian political transition (parliamentary elections June 1999, presidential election September 1999), the 1998 Grasberg wildcat strike, labor agreement expiration in September 1999, and exposure to rupiah volatility.

Pending legal actions (the Beanal and Alomang suits seeking $6 billion and unspecified damages) are being defended vigorously, and management says potential liability would not be material. Reserves rose to 51.3 billion pounds of copper after 1998 additions, but reserve estimates are based on a $0.90/lb copper price and fall about 9% at $0.75/lb.

02—Key points

Key Highlights

Revenue fell 12% to $1.757 billion in 1998 from $2.001 billion in 1997, driven by a 22% drop in average copper realizations to $0.73/lb despite record PT-FI volumes.
Net income applicable to common stock declined 43% to $118.3 million ($0.67/share) from $208.5 million ($1.06/share).
Record PT-FI output of 1.43 billion lbs of copper (up 22%) and 2.23 million oz of gold (up 24%), with ore throughput of 196,400 metric tons per day following the fourth concentrator mill expansion.
Cash production costs of $0.12/lb of copper, 47% lower than 1997, supporting the company's claim of being the world's lowest-cost copper producer.
Stockholders' equity fell to $103.4 million from $278.9 million, reflecting $259.4 million of share repurchases (20 million shares at an average of $12.97).
Common dividend eliminated in December 1998 as part of a cash flow enhancement program; management expects to significantly reduce year-end 1998 debt during 1999.
Proved and probable reserves at PT-FI increased to 40.0 billion lbs of copper, 51.6 million oz of gold and 119.1 million oz of silver net of Rio Tinto's share, with 1998 additions replacing approximately 250% of copper production.

03—Questions

Frequently Asked Questions

Why did FCX's earnings decline sharply in 1998 despite record production?
Production and sales volumes rose substantially, with PT-FI copper sales up 19% and gold sales up 16%. However, average copper realizations fell 22% to $0.73/lb, and gold realizations fell 16%, reducing PT-FI revenues to $1.35 billion from $1.51 billion. Lower metal prices outweighed the volume gains and cost savings, reducing operating income 14% to $574 million.
How did FCX change its capital allocation and shareholder returns?
FCX repurchased 20.0 million shares for $259.4 million in 1998, bringing cumulative buybacks to 50.2 million shares for $1.03 billion, with 9.8 million shares remaining under authorization. In December 1998 the Board eliminated the regular quarterly common dividend (previously $0.05/quarter), citing low copper and gold prices and a goal of reducing debt. Preferred dividends continue to be paid.
What are the main risks to investors from Indonesia?
All mining operations are in Indonesia's Irian Jaya province. Risks include the political transition following President Suharto's May 1998 resignation, parliamentary elections in June 1999 and a presidential election in September 1999, rupiah volatility, and sporadic separatist conflict and human rights allegations. The company also faced a wildcat work stoppage at Grasberg in August 1998, and the union contract expires September 30, 1999. Management says Indonesia's Contract of Work protects against nationalization and that disputes go to international arbitration, but that social and political instability could have a material adverse effect.
How significant is FCX's debt burden and how is it being managed?
Long-term debt including current portion and short-term borrowings was $2.46 billion at year-end 1998, up from $2.39 billion. Interest expense, net, rose to $205.6 million from $151.7 million, largely because of expansion financing and share purchases. Management expects lower debt and interest costs in 1999 through operating cash flow, the dividend elimination, and lower capital spending of roughly $185 million. Note that the company stated that new capital, if available, would be costly.
What is the outlook for FCX's production and costs in 1999?
PT-FI expects 1999 copper sales of approximately 1.4 billion lbs and gold sales of about 2.1 million oz, with higher mill throughput offset by lower ore grades and recoveries. Treatment charges for much of 1999 volume were negotiated lower. The 1999 depreciation rate is expected to rise to 18.0 cents/lb from 17.0 cents, and the FCX/Rio Tinto exploration budget is about $17 million. Reserve estimates would fall roughly 9% for copper if prices dropped to $0.75/lb.

04—Continue

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