Falconbridge Limited - Beedie School of Business

Report
Copper
BUS 419 Presentation
Edward Ng, May Lu, Daphne Hou, Ken Vong, Raymond Au
Copper
• Oldest metal known to humans
• One of the most used and reused
metals
• Infinite recyclable life
Copper
• Known resource 5.8 trillion
pounds
• Only 0.7 trillion pounds (12%) are
mined
• Also essential to human health
Industry
• Global production
• Prices are determined at LME &
COMEX
• Prices might also be affected
through speculative trading and
currency exchange
Source: http://www.unr.edu/sb204/geology/intro.htm
Industry
• 3rd most widely used metal
• Sensitive to political situation
• Producers store copper in
warehouses until it is sold and
shipped to buyer
• Prices: Contango
Industry
Industry
Products
• Sources
– Ore
– Scraps
• Forms
– Rods
– Cathodes
– Concentrate
Products
• Wires
– Substitution
• Fiber Optics
• Pipes/Tubes
– Substitution
• Steel
• Plastics
• Aluminum
Production of Copper
Source: http://www.nymex.com, http://www.copper.org, http://www.lme.co.uk
Industry Suppliers
• Energy (Electricity, Diesel Fuel,
and Natural Gas)
• Scraps
• Ore
• Capital Equipment
(example: Machineries)
Source: http://www.nymex.com
Buyer
• Used in highly cyclical industries
Source: http://www.nymex.com, http://www.copper.org, http://www.lme.co.uk
Industry
%
Building
Electrical
Gen. engineering
Light engineering
Transport
Other
48
17
16
8
7
4
Total
100
Rivals
• 77 firms internationally competing
• Compete on price/low cost
production
• Product Quality
• Customer Service
Key Success Factors
• Economies of Scale
• Refining technologies
• Location
Cost Structure
• Research and Development
• Exploration
• Transportation
• Storage
Cost Structure
• General Operation Cost
• Sales and Administrative
• Interest expenses
• Depreciation, Depletion and
Amortization
Revenue Composition
• Mining revenue
• Financial activities revenue
(example: Hedging)
Risks
• Economic and Political
• Cyclical and Volatile price of
Copper and other substitutes
• Environmental Conditions
• Licenses and Permits
Risks
• Availability of materials and
equipment
• Volatility in energy prices
• Foreign Exchange
• Interest Rate
Risks
• Laws and Regulations
• Weather
• Lower ore grades
• Equipment failure
Hedging Activities
• Energy Prices
• Copper Prices
• Exchange Rates
• Interest Rates
Regulations
• Global Environmental Protection
Laws
– Clean Air Act (CAA)
– Resource Conservation and Recovery
Act (RCRA)
– National Pollutant Discharge
Elimination System (NPDES)
Regulations
• Financial Reporting
– GAAP
– FASB 133
– Bureau of Land Management (BLM)
Phelps Dodge Corporation
Phelps Dodge
• Phelps Dodge Corp. is the world’s
second-largest producer of copper
• World leader in the production of
molybdenum
– Largest producer of molybdenumbased chemicals
• Leading producers of magnet wire
and carbon black
Source: Phelps Dodge Corporation case study, http://www.freemarkets.com/en/literature/ CaseStudy_PhelpsDodge.pdf
Corporate Profile
• Phelps Dodge (PD) is a producer
of:
–
–
–
–
Copper
Carbon black
Magnet wire
Continuous-cast copper rod
• PD consists of 2 divisions
– Phelps Dodge Mining Company
(PDMC)
– Phelps Dodge Industries (PDI)
PDMC
• Comprises 11 reportable
segments
– 5 located in the U.S.
• Morenci, Bagdad/Sierrita, Miami/Bisbee,
Chino/Cobre and Tyrone
– 3 located in South America
• Candelaria, Cerro Verde and El Abra
– Manufacturing and Sales
– Primary Molybdenum
– Other minings
PDMC cont…
• Includes the worldwide, vertically
integrated copper operations from:
–
–
–
–
Mining through rod production
Worldwide mineral exploration
Development programs
Other mining operations and
investments
– Marketing and sales
PDI
• PDI comprises 2 segments
– Specialty Chemicals
– Wire and Cable
Direct Competitors
• BHP Billiton Ltd. (Melbourne,
Australia)
• Codelco (Corporación Nacional del
Cobre, Chile)
• Rio Tinto PLC (London, England)
Cost Structure
• High unit cost structure for copper
production
– lower ore grades
– higher labor costs
– stricter regulatory requirements
• Lean-production program
– Quest for Zero
– Narrows cost disadvantages
– Achieved $330 million of operating
improvements during 2003
Hedging Philosophy
• Not purchase, hold or sell derivative
contracts unless an existing asset,
obligation is present or the occurrence
of a future activity is anticipated and
will result in exposure of market risk
• Not enter into any contracts for
speculative purposes
• Use various strategies to manage
market risks
• Derivative instruments are used to
manage well-defined commodity price,
energy, foreign exchange and interest
rate risks from primary business
activities
Derivative Financial
Instruments
•
•
•
•
•
•
•
•
Metals Hedging
Metal Purchase Hedging
Foreign Currency Hedging
Interest Rate Hedging
Energy Price Protection Programs
Other Protection Programs
Credit Risk
Stock Option Plans
Metals Hedging
• Fair Value Hedges
– Copper fixed-price hedging
• At December 31, 2001, PD had net
futures and swap contracts for
approximately 25 million pounds of
copper
• Cash Flow Hedges
– Copper price protection program
– Copper scrap purchase hedging
Metal Purchase Hedging
• South American wire and cable
operations may enter into aluminum
swap contracts
• These swap contracts settled during the
month of shipment or receipt of metal
• Hedge gains or losses from the swap
contracts are recognized in cost of
products sold
• At December 31, 2001, PD had
outstanding swap contracts for
approximately 13 million pounds of
aluminum
Metal Purchase Hedging
• Metal Hedge Programs in place:
– 2001: 17 Millions
– 2002: 16 Millions
– 2003: 26 Millions
Foreign Currency Hedging
• Fair Value Hedges
– Foreign currency transactions
increase risks
– forward exchange and currency
option contracts
– At December 31, 2001, PD had
foreign exchange contracts in place
with a total face value of
approximately $13 million
Interest Rate Hedging
• Fair Value Hedges
– Fixed-to-Floating interest rate swaps
• In December 2001, PD entered into
several interest rate swap contracts to
hedge $400 million of fixed-rate debt
• PD entered into interest rate swap
contracts to convert fixed-rate debt to
floating-rate debt
• Cash Flow Hedges
– Floating-to-Fixed interest rate swaps
• At December 31, 2001, PD had entered
into interest rate swap contracts to hedge
$364 million of floating-rate debt
Interest Rate Hedging
Floating-to-Fixed interest rate swaps
Swap Contracts
Unrealized
Loss
($ Million)
200
3
200
2
2001
$12
$23
$21
Energy Price Protection
Programs
• Cash Flow Hedges
– Diesel fuel price protection program
• option and fixed-price swap contracts to
price protect 82 percent of the forecasted
diesel fuel consumption.
– Natural gas price protection program
• call option contracts to protect 80 percent
of the planned natural gas consumption
– Feedstock oil price protection
program
Energy Price Protection
Programs
Option Premiums
($ Million)
2003 2002 2001
Diesel fuel price
protection program
$1
$0.9
$1
Natural Gas Price
Protection Program
$3
$2.2
$3
Feedstock Oil Price
Protection Program
$0.8 $0.7
Other Protection Programs
• Copper fixed-price rod sales program
– At December 31, 2001, PD had net futures
and swap contracts for approximately
47 million pounds of copper
• Currency swap transactions
– At December 31, 2001, PD had in place
$15 million in currency swap contracts
• Gold price protection program
• Copper quotational period swap
program
• Other diesel fuel price protection
programs
Other Protection Programs
Unrealized Gain/(Loss) 2003
($ Million )
2002
Copper Fixed Price
Rod Sales Program
$(0.5) $(1.6)
$4.4
Gold Price Protection
Program
$(1.8)
Copper Quotational
Period Swap Program
$1.2
2001
Summary of Price
Protection Program
12/31/03
Fair Value Hedges
Copper fixed-price (lbs.)
12/31/02
11
17
Foreign currency (USD)
$
19
16
Fixed-to-floating interest rate swaps (USD)
$
—
375
10
14
121
274
37
24
8
4
Copper fixed-price rod sales (lbs.)
42
37
Copper quotational period swaps (lbs.)
14
—
Other diesel fuel price protection (gallons)
13
—
Cash Flow Hedges
Metal purchase (lbs.)
Floating-to-fixed interest rate swaps (USD)
Diesel fuel price protection (gallons)
Natural gas price protection (decatherms)
$
Derivative Financial Instruments
Not Qualifying for Hedge Accounting
*Units are in millions
Credit Risk
• PD is exposed to credit loss in
cases where there is a default in
the obligation of the protection
agreement
• Only use highly rated financial
institutions
• Review the creditworthiness
periodically
• The maximum amount of credit
exposure was approximately $8
million
Stock Option Plans
• Executives and other key
employees have been granted
options to purchase common
shares under stock option plans
adopted in 1993, 1998 and 2003
• The option price equals the fair
market value of the common
shares on the day of the grant
• An option’s maximum term is
10 years
Compensation Plan
• Restricted Stock Option Plan
• Directors Stock Unit Plan
Restricted Stock Option Plan
• The issuance of the option to
executives and other key
employees, without any payment
by them
• Subject to certain restrictions
Restricted Stocks
Outstanding at December 31, 2000
Granted
Shares: 219,578
11,700
Terminated
(26,533
)
Released
(15,011
)
Outstanding at December 31, 2001
189,734
Granted
205,700
Terminated
(19,800
)
Released
(16,450
)
Outstanding at December 31, 2002
359,184
Granted
118,000
Terminated
(6,200
)
Released
(19,078
)
Outstanding at December 31, 2003
451,906
Director Stock Unit Plan
• Provides to each non-employee
director an annual grant of stock
units to our common shares
• This plan replaced the 1989
Directors Stock Option Plan
Options outstanding for
the combined plan
Avg option
Price Per Share
Shares
Outstanding at December 31, 2000
8,179,836
Granted
1,420,090
Exercised
Expired or terminated
Outstanding at December 31, 2001
Granted
Exercised
Expired or terminated
Outstanding at December 31, 2002
Granted
Exercised
Expired or terminated
Outstanding at December 31, 2003
$
60.95
34.80
(12,403
)
40.30
(468,670
)
60.73
9,118,853
56.91
802,800
40.12
(8,080
)
30.24
(978,972
)
57.56
8,934,601
55.36
15,500
43.23
(1,958,523
)
50.82
(501,536
)
74.32
6,490,042
55.23
Fair-Value of each option
grant
2003
2002
2001
Expected dividend yield
0.00
%
3.04
%
3.16
%
Expected stock price
volatility
43.4
%
38.8
%
40.9
%
2.9
%
3.3
%
3.4
%
Risk-free interest rate
Expected life of options
5 years
* Using a Black-Scholes option-pricing model to estimate
3 years
3 years
Exercisable options by
range of exercise prices
Range of exercise price
Options exercisable at
Dec. 31, 2003
Weighted average
outstanding option price
$27-40
604,338
$ 34.42
$ 40-60
2,563,606
$ 51.88
$ 60-80
2,266,756
$ 70.02
$ 80-100
129,976
$ 83.82
Total
5,564,676
Financial Analysis
PD’s 2-year Financial Summary
Financial Highlight
• Revenue (2003):
– PDMC $2,485.8 mil
– PDI $1,236.2 mil
• Operating income: 197.6mil
• Net Income: 94.8 mil
• Cash from Operation: $470.50
mil
• ROA: 0.33%
• ROE: 0.16%
• EPS: $ 0.046
Financial Analysis
• Income Statement 2003
• Balance Sheet 2003
• Cash Flow Statement 2003
Revenue History for PD
Quarters
2000
2001
Mar
1,119,700
1,100,700 918,500
978,000
June
1,112,900
1,063,500 966,800
962,200
Sept
1,193,400
937,000
941,200
1,031,100
Dec
1,099,100
901,200
895,500
1,171,400
Total
4,525,100
4,002,400 3,722,000 4,142,700
All figures are in thousands of U.S. Dollars
2002
2003
PD’s stock price (2000-2004)
Falconbridg
e Limited
Section Agenda
•
•
•
•
Company Background
Financial Analysis
Risk Management and Hedging Strategy
Stock Option Plan
Corporate Profile
• Founded in 1928
• Leading low-cost metal producer and metalbearing processor
• Core businesses: copper and nickel
 Ranking twelfth in terms of mined production
 Third-largest producer and account 8% of world nickel
supply
• Market Capitalization: $6.17 Billion
• 6400 employees in 13 countries
• Owned by Noranda Inc. of Toronto (59%), and
other investors (41%) as 2002
Subsidiaries and Associated
Divisions
•
•
•
•
•
Nickel
Sudbury
Raglan
Nikkelverk A/S
Falconbridge
Dominicana (85.26%)
Custom Feed
•
•
•
•
Copper
Collahuasi (44%)
Kidd Mining Division
Kidd Metallurgical
Division
Lomas Bayas
Financial Highlights
•
•
•
•
•
•
•
•
Revenues:
Operating Income:
Earnings:
Cash from operation:
Capital Exp and Def Cost:
ROA:
ROE:
EPS:
2,394 Mil
137 Mil
73 Mil
341 Mil
358 Mil
4%
3%
$0.34
Financial Analysis
• Income Statement
Revenue Source
• Balance Sheet
• Statement of Cash Flow
• 2-year stock price and historical data
Future Outlook
• Remain focus on exploration, development
and production of nickel and copper
metals
• Continue to work closely with Noranda
Cost saving & operation efficiency
• Achieve efficiency, production, and cost
objectives set by each operation.
• Projects are kept in budget and in
schedule
Risk Management &
Hedging Strategy
Risk Management Philosophy
• Earnings are directly related to fluctuations
in the price of its metal.
• Enters into contractual (derivatives)
agreement to reduce (hedge) the
exposure by creating offset position.
• Limited use of financial instruments for
discretionary trading purpose.
• Primary hedges $US/Can currency
exchange rate.
Risk Exposures
• Commodity price risk
Nickel, copper, cobalt, and zinc
Market prices can be affected numerous
uncontrollable factors: e.g., global demand
• Currency exchange risk
Principally in Can/US$ exchange rate
Operating cost in Canadian site are in Can$
Norway site are in Norway
Risk Exposures (Cont’…
• Interest rate risk
Cross-currency
Principally in US and Canadian interest rate
Highly related with interest payable
• Production process risk
Risk and hazard in production
Geographical factors
Subject to monetary loss and possible legal
liability
Risk Exposures (Cont’…
• Energy price risk
Represents a significant percentage of
operating cost
• Contingency risk
Estimation of future restoration
is subject to the change of
law and legislation and
technology innovation
Hedging Strategies
• Commodity price
Futures and options contract for hedging
Purchase call options to fix the price
associated, and reserve upside potential
• Currency exchange
To hedge these currency exposure:
 Issuing debt in the foreign currency denominated
as the investment
 Entering into foreign exchange forward and option
contracts
Hedging Strategies
• Interest ate
 Swap with terms range from 6.5 to 9.5 years
 Fixed to float and float to fixed are used
 Weighted average interest rate was 5.35%
• Production process
 Contract with insurance companies
• Energy price
 Established the three-year 10% cost
reduction plan
 Use the futures and options to hedge
the energy prices
Hedging Effects
• Foreign exchange hedging strategy gained
13.3 million
• Reduced energy cost by 5.0 million from
the part of the three-year 10% cost
reduction plan
• Reduced other expenses by 3.2 million
from futures/forwards and options
positions in current year
Sensitivities of the Change in
Metal Prices
Stock Option Plan
Stock Option Plan
• Two classes of stock option plans:
Employee Stock Option Plan
 Granted to officers and employees
 Exercise price is priced at the fair value using B-S
model since 2002
 Before 2002, exercise = market value
Deferred Share Unit Plan
 Effective in 2002
 Approved for non-employee directors
Employee Stock Option Plan
• Terms and Vesting:
10 year term
vesting provision of 20% on the first
anniversary date and further 20% per year
thereafter
Accelerated vesting feature was attached to
stock options granted since 2000
Deferred Share Unit Plan
• DSU is equivalent to common share
• Elect to be paid annual retainer fee in
deferred share units (DSU) or in cash
• Dividend equivalent will be credited to
DSU when dividend to common share is
approved
• DSU is redeemable in cash or common
shares after resignation
Recommendation
• Hedge Copper, Fuel, Interest rate
and Foreign Exchange
– Capital Intensive
– Better match for R&D expenditures
and future cash flows
Questions?

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