What drove the large increase in FCX's 2005 earnings?

Higher ore grades and mill throughput at the Grasberg mine increased copper sales to 1.46 billion pounds (up 47%) and gold sales to a record 2.8 million ounces (up 93%). Realized prices also rose sharply, to $1.85/lb copper from $1.37/lb and to $456/oz gold from $412/oz. Because much of the cost base is fixed, these volume and price gains flowed through to operating income of $2.18 billion, up from $704 million in 2004.

Is the dividend sustainable, and what did the company return to shareholders?

In 2005 FCX paid $2.50 per share in total dividends, including three $0.50 supplemental payments, and bought back 2.4 million shares for $80.2 million. The regular annual dividend was raised to $1.25 per share. The board retains discretion over supplemental payments, and dividends depend on copper and gold prices and cash needs. Future payouts are therefore variable and tied to commodity prices rather than fixed.

What are the main risks to the investment case?

The main risks are concentration in a single Indonesian operation, with all proven and probable reserves in Block A; political and security risk in Papua, illustrated by the February 2006 protest that suspended mining for about four days; and dependence on the Contract of Work, whose initial term expires in 2021. Commodity price swings are also significant: a $0.10/lb change in copper prices moves annual net income by about $65 million. Mine plan changes and the 2006 accounting shift under EITF 04-6 can also affect reported results.

Will 2006 earnings be as strong as 2005?

Management expects lower 2006 volumes, at about 1.3 billion pounds of copper and 1.7 million ounces of gold, because of mine sequencing and deferred high-grade ore. Net income will also be reduced by the EITF 04-6 change, which charges stripping costs to cost of sales as incurred and removes the deferred mining cost benefit. Results will still depend heavily on metal prices. Management's illustrative case at $2.00/lb copper and $550/oz gold implies operating cash flow of roughly $1.1 billion.

FCX 10-K FY2005 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 15, 2006. Cited figures are marked; the original filing is the authoritative source.

Freeport-McMoRan Copper & Gold (FCX) reported a transformational 2005 for its FY2005 10-K.

Consolidated revenues rose 76% to $4.18 billion^a from $2.37 billion, operating income more than tripled to $2.18 billion from $704 million, and net income applicable to common stock reached $934.6 million ($4.67 diluted EPS) versus $156.8 million ($0.85) in 2004. The results were driven primarily by higher sales volumes at the Grasberg mine in Indonesia (copper sales up 47% to 1.46 billion pounds, record gold sales of 2.8 million ounces) and by realized prices of $1.85/lb copper and $456/oz gold, which were well above 2004 levels. Unit net cash costs fell to $0.07/lb from $0.40/lb, reflecting the volume leverage of a largely fixed cost base.

The company used its cash generation to strengthen the balance sheet and return capital to shareholders. Long-term debt fell to about $1.26 billion^b from $1.95 billion, and cash rose to $764 million. Common dividends totaled $2.50 per share in 2005, including three $0.50 supplemental payments, and the board raised the regular annual dividend to $1.25 per share.

A further $0.50^c supplemental dividend was declared for March 2006. Management guided to lower 2006 sales of about 1.3 billion pounds of copper and 1.7 million ounces of gold, and to a 2006 operating cash flow of roughly $1.1 billion at $2.00/lb copper and $550/oz gold. Investors should weigh the concentration risk in this filing.

Virtually all reserves and production sit in Block A in Papua, Indonesia, under a Contract of Work whose initial term expires in 2021, with extensions still subject to government approval. The filing also highlights political and security risks, including the February 2006 illegal-miner protest that briefly halted operations, the 2003 pit slippage, and the new EITF 04-6 accounting change, which will reduce reported earnings going forward through a $135.9 million^d after-tax cumulative-effect charge to retained earnings in 2006.

02—Key points

Key Highlights

Revenue up 76% to $4.18B and operating income up 209% to $2.18B, driven by a 47% rise in copper sales volumes and a 93% rise in gold sales volumes at PT Freeport Indonesia.
Diluted EPS of $4.67 in 2005 versus $0.85 in 2004; the 2004 result included a $48.8M insurance gain.
Unit net cash costs fell to $0.07/lb of copper from $0.40/lb, with realized prices of $1.85/lb copper and $456/oz gold.
Long-term debt cut to about $1.26B from $1.95B through prepayments, open-market repurchases, and convertible note inductions, with interest savings of about $48M per year expected.
Dividend policy became more generous: $2.50/share paid in 2005, the regular annual rate raised to $1.25, and a further $0.50 supplemental dividend declared for March 2006.
2006 guidance calls for sales of about 1.3B lbs of copper and 1.7M oz of gold, and a February 2006 Gold-Denominated Preferred redemption will create a $69.0M hedging loss in 2006 revenues.
Concentration risk remains high: all proven and probable reserves are in Block A in Indonesia, and the Contract of Work's initial term runs to 2021, with extensions subject to government approval.

03—Questions

Frequently Asked Questions

What drove the large increase in FCX's 2005 earnings?
Higher ore grades and mill throughput at the Grasberg mine increased copper sales to 1.46 billion pounds (up 47%) and gold sales to a record 2.8 million ounces (up 93%). Realized prices also rose sharply, to $1.85/lb copper from $1.37/lb and to $456/oz gold from $412/oz. Because much of the cost base is fixed, these volume and price gains flowed through to operating income of $2.18 billion, up from $704 million in 2004.
Is the dividend sustainable, and what did the company return to shareholders?
In 2005 FCX paid $2.50 per share in total dividends, including three $0.50 supplemental payments, and bought back 2.4 million shares for $80.2 million. The regular annual dividend was raised to $1.25 per share. The board retains discretion over supplemental payments, and dividends depend on copper and gold prices and cash needs. Future payouts are therefore variable and tied to commodity prices rather than fixed.
What are the main risks to the investment case?
The main risks are concentration in a single Indonesian operation, with all proven and probable reserves in Block A; political and security risk in Papua, illustrated by the February 2006 protest that suspended mining for about four days; and dependence on the Contract of Work, whose initial term expires in 2021. Commodity price swings are also significant: a $0.10/lb change in copper prices moves annual net income by about $65 million. Mine plan changes and the 2006 accounting shift under EITF 04-6 can also affect reported results.
Will 2006 earnings be as strong as 2005?
Management expects lower 2006 volumes, at about 1.3 billion pounds of copper and 1.7 million ounces of gold, because of mine sequencing and deferred high-grade ore. Net income will also be reduced by the EITF 04-6 change, which charges stripping costs to cost of sales as incurred and removes the deferred mining cost benefit. Results will still depend heavily on metal prices. Management's illustrative case at $2.00/lb copper and $550/oz gold implies operating cash flow of roughly $1.1 billion.

04—Continue

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