By: Jayson Derrick
Copper is a commodity that many investors believe will appreciate in the coming years. Investors can invest directly in copper through various exchange traded products such as Global X Copper Miners (COPX), iPath Pure Beta Copper (CUPM) and U.S. Copper Index (CPER). Alternatively, investors can buy shares of companies that are involved in the copper business like Freeport-McMoRan (FCX). Freeport is the largest publicly traded copper and molybdenum producer in the world, and the stock is a bargain at around $33 a share given the long-term prospects of the commodity, and the positive direction the company is heading in.
The stock is trading at a discount to other diversified metals and mining companies, which is unwarranted despite concerns following the company's announced intention to acquire Plains Exploration & Production Company (PXP) for $6.9 billion in cash and stock as well as McMoRan Exploration (MMR) for $3.4 billion in cash. Investors were wondering the strategic merit and return potential from the acquisition, and that has reduced investor confidence in the company's strategic direction.
I find such concerns to be valid ones, but that does not justify the stock's current price. I believe that in the coming months and years, Freeport's stock should re-rate and its valuation multiples start rising back towards those of its peers for three reasons:
Premium asset mix
If the acquisition is completed, Freeport would still have the greatest copper exposure amongst its peers, with a strong exposure in oil and gold, both of which are generally viewed as having long-term positive outlooks. The other major global diversified miners have very large exposure to steelmaking raw materials, iron ore and met coal, where supply/demand fundamentals are just not as strong when compared to copper and oil.
Strong copper projects
The copper market and industry has been tight over the past several years as the market faced declining grades, rising capital expenditures, labor shortages and high infrastructure costs associated with developing new deposit sites. Freeport is in a great position and has the capability to add almost 1 billion pounds of copper production over the next few years, an increase of around 25% of the current production capacity. Higher copper prices will allow the company to continue generating strong cash flows as all major projects are already permitted and all projects are brownfield expansions, which generally have a lower risk profile. The company's copper mining business has generated significant free cash flow in the past and there is no reason to assume that this will not continue moving forward.
Oil and gas assets
The assets that Freeport should acquire will provide the company with a solid exposure to oil and gas with strong project outlooks. Plains Exploration has emphasized oil over natural gas in recent years; the most notable acquisition was the $6.1 billion for Gulf of Mexico assets from BP/Shell that had 67 MBOE/day of production and 127 MMBOE of proved reserves. Freeport should be able to leverage existing infrastructure to increase production levels and make more reserves economically viable in the same area. Management can always use the cash flows to fund capex for future copper projects and oil & gas explorations.
Since the acquisition announcement on December 5, 2012, Freeport's stock has underperformed its peers by an average of 16%. I see the stock as undervalued and extremely attractive for any investor who requires exposure to commodities. The stock can easily be trading above $40 in the near future and I really like the 3.8% dividend yield that is currently offered. While commodity prices continue to be volatile, I have little doubt that within the next few years commodities will be more valuable than today. Freeport is as good of an investment decision as can be made to profit from rising commodity prices.