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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

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copper

Copper

BUS 419 Presentation

Edward Ng, May Lu, Daphne Hou, Ken Vong, Raymond Au

copper2
Copper
  • Oldest metal known to humans
  • One of the most used and reused metals
  • Infinite recyclable life
copper3
Copper
  • Known resource 5.8 trillion pounds
  • Only 0.7 trillion pounds (12%) are mined
  • Also essential to human health
industry
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

industry5
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
products
Products
  • Sources
    • Ore
    • Scraps
  • Forms
    • Rods
    • Cathodes
    • Concentrate
products9
Products
  • Wires
    • Substitution
      • Fiber Optics
  • Pipes/Tubes
    • Substitution
      • Steel
      • Plastics
      • Aluminum
production of copper
Production of Copper

Source: http://www.nymex.com, http://www.copper.org, http://www.lme.co.uk

industry suppliers
Industry Suppliers
  • Energy (Electricity, Diesel Fuel, and Natural Gas)
  • Scraps
  • Ore
  • Capital Equipment (example: Machineries)

Source: http://www.nymex.com

buyer
Buyer
  • Used in highly cyclical industries

Source: http://www.nymex.com, http://www.copper.org, http://www.lme.co.uk

rivals
Rivals
  • 77 firms internationally competing
  • Compete on price/low cost production
  • Product Quality
  • Customer Service
key success factors
Key Success Factors
  • Economies of Scale
  • Refining technologies
  • Location
cost structure
Cost Structure
  • Research and Development
  • Exploration
  • Transportation
  • Storage
cost structure16
Cost Structure
  • General Operation Cost
  • Sales and Administrative
  • Interest expenses
  • Depreciation, Depletion and Amortization
revenue composition
Revenue Composition
  • Mining revenue
  • Financial activities revenue (example: Hedging)
risks
Risks
  • Economic and Political
  • Cyclical and Volatile price of Copper and other substitutes
  • Environmental Conditions
  • Licenses and Permits
risks19
Risks
  • Availability of materials and equipment
  • Volatility in energy prices
  • Foreign Exchange
  • Interest Rate
risks20
Risks
  • Laws and Regulations
  • Weather
  • Lower ore grades
  • Equipment failure
hedging activities
Hedging Activities
  • Energy Prices
  • Copper Prices
  • Exchange Rates
  • Interest Rates
regulations
Regulations
  • Global Environmental Protection Laws
    • Clean Air Act (CAA)
    • Resource Conservation and Recovery Act (RCRA)
    • National Pollutant Discharge Elimination System (NPDES)
regulations23
Regulations
  • Financial Reporting
    • GAAP
    • FASB 133
    • Bureau of Land Management (BLM)
phelps dodge
Phelps Dodge
  • Phelps Dodge Corp. is the world’s second-largest producer of copper
  • World leader in the production of molybdenum
    • Largest producer of molybdenum-based 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
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)
slide27
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
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
slide29
PDI
  • PDI comprises 2 segments
    • Specialty Chemicals
    • Wire and Cable
direct competitors
Direct Competitors
  • BHP Billiton Ltd. (Melbourne, Australia)
  • Codelco (Corporación Nacional del Cobre, Chile)
  • Rio Tinto PLC (London, England)
cost structure31
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
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
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
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
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 hedging36
Metal Purchase Hedging
  • Metal Hedge Programs in place:
    • 2001: 17 Millions
    • 2002: 16 Millions
    • 2003: 26 Millions
foreign currency hedging
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
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 hedging39
Interest Rate Hedging

Floating-to-Fixed interest rate swaps

Swap Contracts

energy price protection programs
Energy Price Protection Programs
  • Cash Flow Hedges
    • Diesel fuel price protection program
      • option and fixed-price swap contracts to price protect 82percent 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
other protection programs
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
summary of price protection program

12/31/03

12/31/02

Fair Value Hedges

Copper fixed-price (lbs.)

11

17

Foreign currency (USD)

$

19

16

Fixed-to-floating interest rate swaps (USD)

$

375

Cash Flow Hedges

Metal purchase (lbs.)

10

14

Floating-to-fixed interest rate swaps (USD)

$

121

274

Diesel fuel price protection (gallons)

37

24

Natural gas price protection (decatherms)

8

4

Derivative Financial Instruments

Not Qualifying for Hedge Accounting

Copper fixed-price rod sales (lbs.)

42

37

Copper quotational period swaps (lbs.)

14

Other diesel fuel price protection (gallons)

13

Summary of Price Protection Program

*Units are in millions

credit risk
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
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
Compensation Plan
  • Restricted Stock Option Plan
  • Directors Stock Unit Plan
restricted stock option 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

Shares: 219,578

Granted

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

Restricted Stocks
director stock unit plan
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

Shares

Avg option Price Per Share

Outstanding at December 31, 2000

8,179,836

$

60.95

Granted

1,420,090

34.80

Exercised

(12,403

)

40.30

Expired or terminated

(468,670

)

60.73

Outstanding at December 31, 2001

9,118,853

56.91

Granted

802,800

40.12

Exercised

(8,080

)

30.24

Expired or terminated

(978,972

)

57.56

Outstanding at December 31, 2002

8,934,601

55.36

Granted

15,500

43.23

Exercised

(1,958,523

)

50.82

Expired or terminated

(501,536

)

74.32

Outstanding at December 31, 2003

6,490,042

55.23

Options outstanding for the combined plan
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

%

Risk-free interest rate

2.9

%

3.3

%

3.4

%

Expected life of options

5 years

3 years

3 years

Fair-Value of each option grant

* Using a Black-Scholes option-pricing model to estimate

financial analysis
Financial Analysis

PD’s 2-year Financial Summary

financial highlight
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 analysis56
Financial Analysis
  • Income Statement 2003
  • Balance Sheet 2003
  • Cash Flow Statement 2003
revenue history for pd
Revenue History for PD

All figures are in thousands of U.S. Dollars

section agenda
Section Agenda
  • Company Background
  • Financial Analysis
  • Risk Management and Hedging Strategy
  • Stock Option Plan
corporate profile61
Corporate Profile
  • Founded in 1928
  • Leading low-cost metal producer and metal-bearing 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

Subsidiaries and Associated Divisions
financial highlights
Financial Highlights
  • Revenues: 2,394 Mil
  • Operating Income: 137 Mil
  • Earnings: 73 Mil
  • Cash from operation: 341 Mil
  • Capital Exp and Def Cost: 358 Mil
  • ROA: 4 %
  • ROE: 3 %
  • EPS: $0.34
financial analysis65
Financial Analysis
  • Income Statement
    • Revenue Source
  • Balance Sheet
  • Statement of Cash Flow
  • 2-year stock price and historical data
future outlook
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 philosophy
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 $US/Can currency exchange rate.
risk exposures
Risk Exposures
  • Commodity price risk
    • Nickel, copper, cobalt, and zinc
    • Market prices can be affected numerous uncontrollable factors: e.g., global demand
  • Currency exchange risk
    • Principally in Can/US$ exchange rate
    • Operating cost in Canadian site are in Can$
    • Norway site are in Norway
risk exposures cont
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 cont71
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
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 strategies73
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
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
stock option plan77
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
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
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
Recommendation
  • Hedge Copper, Fuel, Interest rate and Foreign Exchange
    • Capital Intensive
    • Better match for R&D expenditures and future cash flows