DOING SOME DIGGING – Musings on a month in the life of Falconbridge

Last week FALCONBRIDGE LTD. released its financial numbers for the month of April 2006. The numbers were all great....
Last week FALCONBRIDGE LTD. released its financial numbers for the month of April 2006. The numbers were all great. Revenues almost doubled to US$1.3 billion ($0.64 per share) compared with April a year earlier. Net income was US$238 million, up 194% from the same period a year ago. The price of copper was up 87%, nickel up 6%, zinc up 118% and aluminum up 22% this April over April 2005.

Falconbridge has earned as much in a month as it would normally in a quarter, or even in a year. It may be the first company to release a monthly earnings report, but these are unusual times for Falconbridge.

The success of this month is driven by the company's copper business (due to the very high copper price), which is by far the largest part of the company's US$422-million income generated by operating assets. If anything, nickel was a liability in April 2006, in that it generated less income than a year ago.

This makes one think that diversification is good. The new Falconbridge, created by the Noranda-Falconbridge merger last year, is a diversified company, although not quite as diversified as INCO LTD.'s suitor TECK COMINCO. Perhaps the real benefit that Inco sees in pursuing Falconbridge is not to become the world's largest nickel company, but to make itself more diversified.

Hidden among the operating results are a number of warning bells. If it were not for the very high prices of the four metals that make up the bulk of Falconbridge's production, the company would be suffering the effects of steeply increased costs. This is partly due to increased volumes of material (pushing more ore and custom feed through its plants) to take advantage of high prices, but these costs could easily be cut by reducing volumes. The more serious problems are the high price of energy and supplies/consumables, and the weak U.S. dollar, which negatively affects operations in Canada and South America, i.e., almost all of Falconbridge's mines.

What I see is a company taking home buckets full of money every day right now, but a company that could be in a tough position in five years or sooner, whenever metal prices dip below their long-term averages. (This is true not only for Falconbridge but for every company that uses energy and supplies, and is dependent on the American dollar.)

What Falconbridge should be doing with those buckets full of money is investing in new, cleaner, more efficient equipment and methods (and research into these) to weather the inevitable arrival of lower commodity prices. Instead, the four companies riding the takeover merry-go-round (XSTRATA PLC is the fourth) are frittering away their money on financial, legal and accounting advice in an orgy of takeover bids. There will likely be big payouts for the many executives who are eventually let go ("synergies"). When this is all ironed out in six or 12 months, it's probably going to be too late to invest in those efficiencies that the contenders should be working on right now.

By the way: what's so smart about buying at the top of the market? Teck Corp. was successful in the past just by moving in when the market was low and quiet, when no one else was interested, and the price was right. How smart will Inco's or Xstrata's almost-US$20-billion bid for Falconbridge look a year or two from now when the company's returns are mediocre. I predict some massive write-downs in the future of the "winner".


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