THE SLAUGHTER IN THE MINING PROFIT MARGINS BEGINS

Freeport just came out with their 1st half 2012 financial results and it was terrible.  Even though they had a slowdown at their Indonesian Grasberg mine in the first quarter, the real damage was due to the prices paid for Copper and Moly.  I knew that profit margins were going to get clobbered this second half, but Freeport’s net income declined nearly 50%.

Freeport McMoRan Copper & Gold is more a base metal company, but they do produce a substantial amount of gold.  In 2011, Freeport produced 1.4 million oz of gold.

If we look at the chart below we can see just how horrible their YOY (year over year) financial results have been:

 Total revenues for the first half of 2012 fell $2.4 billion compared to the same period in 2011…. or a 21% decline.  You would think if production volumes decreased, so would the cost of sales.  In the highlighted RED AREA, you will see that in Jan-Jun 2011 cost of sales were $5.43 billion on revenues of $11.52 billion.  However, if we look at Jan-Jun 2012 we see that Freeport’s cost of sales actually increased to $5.6 billion on much lower revenues of $9.0b billion. 

WHAT’S THE DEAL??

The next chart shows how lower metal prices on top of increased costs are killing profit margin by miners:

If we look at the data in more detail, we find out that the GOLD PORTION of Freeport’s first half financials actually helped buffer the losses.  Overall copper production declined 10%, whereas gold production fell a staggering 38%.  Moly did not change all that much.  If we compare some of the data, we can see just how bad the base metal prices are destroying Freeport’s margins:

2011 Jan-Jun Copper Sales = 1,928 million lbs X $4.24 = $8.2 billion

2012 Jan-Jun Copper Sales = 1,754 million lbs X $3.61 =$6.3 billion

Difference in total Copper Revenue = $1.9 billion (this is the majority of Freeports losses)

However, if we take the same amount of 2012 Jan-Jun sales and multiply it by last years copper price per pound of $4.24 we get the following:

2012 Jan-Jun Copper Sales = 1,754 million lbs X $4.24 =$7.4 billion

Difference in total Copper Revenue (based on last year copper price) = $800 million

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Here we can see that the price difference from $4.24 (1H 2011) to $3.61 (1H 2012) becomes the larger killer of revenue.  Even though copper production fell 10% which was bad enough, the price of copper Freeport received fell 15%.

As I mentioned before, Gold actually helped buffer some of Freeport’s losses even though its gold production declined a whopping 38%.  Here are the figures:

Jan-Jun 2011 Gold Sales = 836,000 oz X $1,466 = $1.2 billion

Jan-Jun 2012 Gold Sales = 554,000 oz X $1,639 = $908 million (-24%)

But, if we were to used last years price and applied to the large decline in gold production this would have been the result:

Jan-Jun 2012 Gold Sales = 554,000 oz X $1,466 = $812 million (-32%)

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The damage done to Freeport’s first half financials were mainly due to its copper and moly metals.  The price Freeport received for both copper and moly fell 15% compared to the same period last year.  However, the average gold price they received actually increased 12%.

I believe the large gold miners (Barrick, NewMont, Goldcorp, Newcrest, AngloGold and etc) will not suffer much damage to their profit margins first half year compared to last year.  This is because the price of gold was much higher in the second half of 2011 than the first half. 

On the other hand, the major silver companies will show a big decrease in profits due to the fact that silver hit its high in the first half of 2011.

Stay tuned for more analysis as the results come out….